FX Talking: Bond vigilantes take control

The rising tide of global bond yields – especially US bond yields – is becoming the dominant theme in global FX markets. Whether it is views of structurally higher policy rates or ‘bond vigilantes’ demanding governments take fiscal responsibility more seriously, the net result is tighter financial conditions. This is normally a dollar positive.

Concerns over the ‘erosion of governance’ of the US budget trajectory look unlikely to be soothed any time soon. Additionally, it looks as though the Fed may keep its hawkish bias for a little longer. This means that despite November and December typically being weak months for the dollar, the dollar may in fact hold recent gains into year-end.

As always, the dollar is the currency of the United States and everyone else’s problem. Here we expect Chinese and Japanese officials to keep battling to support their currencies at 7.30/$ and 150/$ respectively. EUR/USD does not look particularly undervalued and in addition to weak eurozone growth, we are concerned that the re-introduction of the Stability and Growth Pact next year could keep the euro soft.

The ING view remains that three quarters of US contraction and a 200bp Fed easing cycle will take its toll on the dollar – hence our bearish 12-month forecasts.

In terms of the broader environment, tighter financial conditions have driven volatility levels higher and sparked an unwind of the FX carry trade. That may well continue this month and is a negative for most EM currencies. Additionally contentious elections in Poland and Argentina this month could add to volatility in the EMFX complex.