US Dollar Rallies Despite Plummeting Treasury Bond Yields - What Gives?

Mixed US economic data had little effect on the domestic currency, with an exactly as-expected result in the key Consumer Price Index report having no immediate effect on market sentiment. Indeed, interest rate futures remained almost exactly unchanged in immediate aftermath of the highly-anticipated inflation report. A later tumble in the Dow Jones Industrial Average was the most market-moving event of the session, and it seems as though risk sentiment continues to deteriorate into late New York trading. Given a sharp decline in US Treasury Bond yields, investors are clearly showing their reluctance to buy and hold risky US stocks.

Interest rate futures have responded in kind, and the implied yield on the December Federal Reserves Funds Future fell a significant 5 basis points to 4.32 percent. Such price action shows that traders predict a 92 percent chance that the Fed will cut interest rates by a minimum of 25 basis points to 4.25 percent. Under   and markets continue to expect that the US Federal Reserve will cut interest rates at its upcoming meeting. Under normal market conditions, falling US bond yields and Fed rate expectations would hurt the dollar. Yet we continue to see market risk aversion trump changes in yield differentials across key risk-sensitive currencies.  

The Dow Jones Industrial Average continued to suffer on market risk aversion, losing 0.4 percent to 13,180 through late New York trading. Losses were clearly distributed among the broad spectrum of US stocks, as the S&P 500 was the largest decliner at -0.8 percent to 1,459. The tech-heavy NASDAQ Composite was not far behind as it shed a further 0.6 percent to 2,630.

US Treasury Markets were unsurprisingly volatile through the trading session. In a move one would normally see in emerging market government debt, the 2-year US Treasury Note shed a whopping 14 basis points to 3.36 percent. The combination of worsening risk sentiment and interest rate outlook sunk the yield to fresh 33-month lows, and a strong uptrend in bond prices showed few signs of abating through active trading. 

Written by David Rodríguez, Currency Analyst for DailyFX.com