(Bloomberg) -- Donald Trump has blamed the stubbornly strong dollar on the Federal Reserve’s reluctance to slash interest rates further. But real yields suggest investors fearful of the president’s trade war are what’s keeping the greenback strong.
Consider the evidence: the U.S. currency has advanced against seven of 10 major peers this year even as the premium on inflation-adjusted Treasury yields over that of other major debt markets has narrowed since November.
Implied 10-year U.S. real yields have fallen more than a percentage point from a November high to 0.05%, driven by the Fed’s rate cut amid muted inflation expectations.
The dollar has remained bid as investors seek shelter in havens amid growing concerns the trade dispute could tip the global economy into a recession.
“It’s natural for the dollar to be strong,” said Daisaku Ueno, chief currency strategist at Mitsubishi UFJ Morgan Stanley (NYSE:MS) Securities Co. in Tokyo. “Trump is waging a trade war against economies that earn a surplus from the U.S. and making the strong American economy even stronger.”
Money markets are fully pricing in a further 1% of Fed rate cuts by end-2020. But Boston Fed President Eric Rosengren, who voted to keep rates unchanged at the last review, on Monday downplayed the need for more easing, saying he’s not convinced that slowing trade and global growth will significantly dent the U.S. economy.
Investors may gain more insight on the outlook for U.S. interest rates and the fallout from the trade war when policy makers gather at the Jackson Hole symposium and the Group-of-7 meeting over the coming week.
The dollar’s outperformance has prompted Trump to attack Fed policy for eroding the U.S.’s competitive edge. The Dollar Index advanced in five of the first seven months of 2019 and rallied to the highest in more than two years in August.
The inflation-adjusted yield differential used in the chart above was constructed using 10-year inflation-linked bonds issued by the U.S., Germany, Japan, U.K., Canada and Sweden. The average was derived using the same weights as those for the Dollar Index, minus Switzerland, which was excluded as it does not issue comparable sovereign securities.
