There have been some strange developments this week in interest rates and currencies. First, the European union reported inflation above target, leading to the conclusion that interest rates will not be cut in the near term, rather stay where they are. Normally, one would expect the Euro to appreciate against the US dollar based on a higher Euro yield. And, given investors see a 90% chance of a US Fed interest rate cut, the Euro should have strengthened, and the dollar weakened.
This did not happen; the Euro was -.57% shortly after the inflation announcement, and the US dollar, as measured by DXY, rose about the same as the Euro went down. In the case of the Euro, currency weakness may be explained by debt concerns. Borrowing concerns in Germany led to the German 30 year bond going to the highest yield since 2011, the time of the last European sovereign debt crisis. A move so strong in the 30 year expresses the fact that investors are demanding a high rate of interest to compensate for the risk of government financing in Germany. At the same time, French government debt is the key issue in the determination of the new prime minister.
As a general statement, regarding Europe, the risk of debt and borrowing is overpowering higher interest rates.
If debt and borrowing are the new concerns, the US must watch out. While the Fed decision on interest rates this month is monumental, investors should pay more attention to how the US government is going to stay open past September 30, 2025, without budget adjustments and a new debt ceiling. Also, the magnitude of the interest rate cut, supposedly coming this month, must be taken into consideration. A .25% rate cut is already discounted in bond prices, so its announcement will probably create a whimper for bond markets rather than a bang, hardly supportive.
Regarding the borrowing limit, it is no secret that congress cannot agree. Democrats and republicans disagree on almost everything, but there are some republicans who don’t agree with other republicans. These are the fiscal hawks who will push for spending cuts before they vote on more debt. Keeping the US government open will not be easy, which will create uncertainty among investors.
Congressional disagreement on borrowing aside, the real issue is upcoming debt issuances; the US 10-year bond auction will be September 10, the 30-year September 11, and the 20-year September 16. The Fed meeting is September 17. If the 10-year or 30-year bond auction go bad, experience low demand , the US dollar could be at risk.
To use president Trumps language, the bond market may get the “yips” like it did in April. If the bond market gets the yips, the US dollar will too.
When investors demand higher yields for longer maturity government bonds, they are demanding compensation for the risk over time of holding government bonds. Right now, investors are demanding higher compensation with the US 30-year bond hovering around 5%. They seem to believe they are taking a lot of risk in long dated US Treasuries. Investors are signaling that they are worried about the future financial state of the US long-term.
Once again, the true test of whether US bonds get the yips will be the upcoming auctions. Close attention be paid to these auctions, and the US had better hope they go well, or the concern that is building will accelerate and show up in dollar weakness, the yips.
Given concerns noted above, US dollar, investors, whether fiat of tokenized, should diversify away from the US dollar. At least until more is known regarding the upcoming auctions and the debt ceiling.
Although Etherfuse Euro bonds have a low APY of 1.47%, the currency can make up for a low yield if the dollar gets the yips. UK Gilts at an APY of 3.92% could make sense. Probably the standout investments for reducing US dollar exposure are the Mexican Cetes at 6.2%APY and the Brazilian Tesouro at 13.06% APY.
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