Bonds and the Dollar

The dollar has had a small rebound off its 3 year low and many are wondering if this is a good sign to buy into the greenback strength. Many of the indicators point to a higher Dollar, stronger economic growth, Higher interest rates in the US, and (so far) low inflation. Looking at a one month chart of the dollar index to the price of the 10 year treasury, you can see that the movement of the dollar to other currencies was in high correlation to the price of US bonds. Because yields move inverse to bonds, it could be assumed that lower bond prices (and higher yields) make the dollar become an attractive place to put money relative to other currencies. This trend should be watched to see if investors are using this as a short term trading catalyst or if the introduction of equity risk increased the relationship between bonds and the dollar.

Looking over a longer term trend there is a story to be told. The movements between the dollar and the yields in the past have been in sync (as you can see by the opposite movements in the chart) until the last 6 months where yields have dropped and the dollar followed suit. The cause of this could be a combination of many things, such as inflation expectations getting revised higher, or the political gridlock we have seen over the tax cuts and budget bill. It is certainly an adjustment to the expectations of that yields will not be lower for longer like we have seen in the past. Where is the 'proper' level to bring yields back to an attractive level that investors are bullish on holding dollar debt? Shorter term the answer looks like now, longer term we have to watch, inflation, the fed, and politics to determine what will make the US debt market investable again for large foreign buyers.