U.S. dollar and bond yields rally on a resilient labour market

The DXY-U.S. dollar index climbed above the key 107 level for the first time since mid-November 2022, driven by the ongoing rally of the U.S. Treasury yields and the expectation for higher-for-longer interest rates.

The dollar index, a measure of the greenback’s standing against six leading global currencies, climbed as high as 107.30, posting a fresh 11-month high. The strong dollar added pressure on the major peers, driving down the Euro to $1,0440, the Pound Sterling to $1.21, and the Japanese Yen to ¥150, while the growth-sensitive Australian and New Zealand dollars posted fresh yearly lows of $0.6280 and $0.5870 respectively.

DXY-dollar index, Daily chart

What caused Tuesday's greenback and bond yield rally was the higher-than-expected U.S. Job Openings and Labor Turnover Survey for August. The survey showed 9.61 million job openings in the month, higher than the 8.8 million that economists previously surveyed by Dow Jones anticipated.

The jobs reading signaled a strong U.S. labor market, which could prompt the Federal Reserve to raise interest rates further in the next meetings and to keep its hawkish stance for longer. The central bank began hiking rates in March 2022 to ease inflation and cool the economy, including the labor market.

The pledge by the Federal Reserve to keep interest rates at a higher level for longer to curb resilient inflation together with Tuesday’s resilient job data triggered a rally on the T-yields yesterday, with the 10-year Treasury yield surging as high as 4.884%, reaching its highest level in 16 years.

10-year U.S. Treasury yields, Daily chart

The 2-year yield also jumped to near monthly highs of 5.16%, while the 30-year Treasury yield touched the critical 5% mark, its highest yield since May 2009, fuelling fears that the U.S. economy would tip into recession.

Investors are also concerned that a ballooning federal budget deficit might lead to more supply of bonds to meet obligations but also require higher yields to clear the market.

Another recession warning is the inversion of the 2-year and 10-year Treasury yield curve (5.16% > 4.88%) a phenomenon that has historically been a reliable recession predictor (It typically takes 1.5-2 years for a recession to occur).

The yield curve inversion indicator rung correct for four of the five last recessions (excl. CoViD) and it most recently inverted in June 2022 (which means we’re due for a major contraction leading up to and within the next 9mos).

In this context, traders dumped the risk and growth-sensitive stocks for the safety of the dollar, sending the major indices of Dow Jones, Nasdaq Composite, and S&P 500 to 4-month lows, and the dollar-denominated Gold down to nearly $1,820/oz.

The market participants are concerned that the surging interest rates would freeze the business activity and housing market, which could potentially tip the U.S. economy into a hard or soft landing.