Chart of the Month
Over the past 15 years, the real interest rate differential has been an important driver of the US Dollar index or NEER (nominal effective exchange rate). NEER measures the strength of a currency as the weighted average of bilateral exchange rates with its major trading partners. Until last month, when the Fed reduced its target funds rate for the first time in almost a decade, market participants had favoured the greenback against lower-yielding currencies, especially negative yielding ones (i.e. Yen and Euro). If US policymakers decide to cut rates aggressively in order to counter the negative effects of uncertainty on economic growth, could this mark the end of the US Dollar bull trend?
Despite a drop in the broadest measure of annual global inflation in Q1, from 2.9 to 2.5 per cent, remarkably, the number of countries with high inflation rates than a year ago outnumbers those with lower annual rates by 26 to 9. The Q4 slump in traded goods prices knocked back inflation in China, Indonesia, Malaysia and Philippines, and modestly in US, but in Europe, EMEA (ex-Russia) and Latin America, the inflation trend is holding firm.
While US stocks have lost ground since the Q1 recovery, Treasury bond yields have continued to fall across the yield curve, with the 10Y down 50bps to 2.1% since the beginning of January. As a consequence, real yields have also dropped below 40bps, their lowest level since September 2017. While the fit is far from perfect, the chart shows that the annual change real yields tend to lead real GDP growth by around 1 year and currently price in a sharp deceleration in activity towards the end of 2019.
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