US dollar rally is back and now it has the bond market behind it

[NEW YORK] The US dollar is on a tear again and this time it has the support of a key ally: the interest-rate market.

The US currency reached a six-month high against the euro as two-year dollar interest-rate swaps exceeded those in the shared-currency area on Tuesday by the most since 2007. That's a change of fortune for the greenback, when its advance fizzled back in March after the differential in interest-rate swaps collapsed.

The derivatives market metric has moved largely in tandem with currencies during the past two years.

Higher US interest rates compared with European peers reflect growing sentiment that the Federal Reserve will increase boost its benchmark target in December, while the European Central banks considered adding to its monetary stimulus.

"US rates are now doing most of the work in the divergence story," said Vassili Serebriakov, a New York-based foreign-exchange strategist at BNP Paribas SA.

"US front-end yields will keep moving higher as long as the Fed keeps hiking. We'll see how much higher the Fed can push the dollar."

The dollar rallied 0.3 per cent to US$1.0724 against the euro at 5pm in New York, the strongest level on a closing basis since April 15. The US currency has gained 2.6 per cent this month, moving closer to US$1.0458, a level reached in March that was the strongest since January 2003.

RATE WATCH

The gap between US and euro-area two-year swap rates widened 15 basis points this month, and reached 1.02 percentage point on Tuesday.

Speculation about a Federal Reserve liftoff in December surged after the release of stronger-than-forecast US labour data on Nov 6, driving US rates and currency higher. Traders see a 66 per cent chance that the Fed will raise its benchmark rate from near zero at its next meeting, up from a 56 per cent probability before the report. The calculation assumes the effective fed funds rate averages 0.375 per cent after the first hike.

"The dollar has strengthened a lot, some people sort of think that maybe it's done, but from our perspective, it probably goes another five percent or ten percent," Scott Mather, chief investment officer for core strategies at Pacific Investment Management Co, said on Nov 6 on Bloomberg Television.

"As the Fed begins to get off zero, there will be money that comes into the US just to park on the short end of the yield curve."

The Bloomberg Dollar Spot Index, which tracks the greenback versus 10 major counterparts, climbed 0.1 per cent, reaching the highest level in more than a decade.

BLOOMBERG