The US dollar against a basket of main currencies has gradually appreciated by more than 6% in just over two months and is at its strongest in 2023. The EUR/USD pair is breaching 1.06 and has been at lows since March. The US currency is supported by the continuation of the sell-off in government bonds, which is driving the emerging market world into trouble.
US dollar: falling bonds push the USD to this year's highs
The leading piece of the market jigsaw, which sets the trend in currency quotations and dictates the mood of stock markets, is again the debt sell-off and the strong rise in US Treasury bond yields. This is the most obvious and unambiguous trend at the moment. In the case of US bonds with a maturity of 10 years, yields are now above 4.5% for the first time since 2007, kicking off a fourth consecutive week of increases with momentum. Emerging market currencies are traditionally particularly sensitive to this factor, but so is the yen, which is deprived of monetary policy support. The USD/JPY exchange rate is approaching the 150.00 ceiling, raising speculation that interventions to support the Japanese currency are hanging in the air.
Pushing the dollar to new highs, the fall in bond prices is being driven by, among other things, the Federal Reserve's restrictive monetary policy. Following last week's FOMC meeting, investors are losing hope that interest rates in the US can fall quickly. The US economy impresses in comparison to its competitors with the strength of its economic growth, with the Atlanta Fed's GDP growth estimation model suggesting that GDP growth in the coming quarter in annualised terms should be around 5%. An important factor supporting the trend in the debt market may also be the rising price of oil on world markets, which is acting towards stronger price pressure. The price of a Brent barrel has been hovering near the 95 USD ceiling for more than a week, which means that it has risen by around a quarter since the end of June.
US dollar: government shutdown threatens rating cut by Moody's
In the background, another political spat in Congress is playing out that could have an impact on US Treasury bonds. This time, the impasse concerns the budget bill, which should be passed before the end of September. In the past few decades, you can count on the fingers of one hand the number of times this has succeeded. Usually, the solution was a temporary bill, but this time, the Republicans are showing no willingness to find an agreement quickly.
As a result, the real threat is that October will start with the paralysis of the US administration and the suspension of work by numerous government agencies, the so-called government shutdown. This would not be an unprecedented situation. In fact, the last and longest such episode in history, lasting as long as 35 days, took place at the turn of 2018 and 2019. If not avoided this time, it will likely have negative consequences for the US credit rating. Moody's, the last agency to maintain the rating at the highest possible level, has already warned that a government shutdown would be evidence of institutional inefficiency and fiscal policy instability. To recall, similar arguments were cited by Fitch, which in August reduced its credit rating from the maximum ceiling by one rank.
The real shock was the credit rating cut by S&P in 2011. The last decision by Fitch, although it triggered an avalanche of comments, was calmly received by investors. This time, it should be similar. Above all, we see no threat to the dollar in the rating changes. Neither its short-term strength (after Fitch's cut, the USD rose in price on a wave of short-term risk aversion), nor its position as the leading reserve currency. The US Treasury bond plays such a fundamental role in the international financial system that investors will not turn away from it regardless of whether the rating is at the highest or second-best level. The US remains in a uniquely privileged role. Governments are deaf to the agency's recommendations, and they are not translated into the health of public finances. As a result, they do not impact either debt supply or complementary fiscal policy, and only then would US credit rating changes have a real impact on market trends.