The Dollar Is Spiking While Interest Rates Crash Here s Why

The dollar is rising again and that pressure is being felt right across Asia. Japan's yen is weak. South Korea's won is tumbling. Indonesia's rupee a record low. India's rupee continues to give officials their just absolute fits. But as all that is taking place at the very front of the U.S. dollar interest rate market, it's doing something incredible. Shocking even. The complete opposite of what you'd think. But here's the thing. These two developments are really the same thing. Why the dollar is hammering Asia and how that would play out in short-term U.S. dollar interest rates. Now for currencies, the mainstream explanation is simple. It's always interest rates. The Fed, they say, is still too high. The Bank of Japan, for example, too low. Asian central banks are behind the curve. Rate differential. Speculators. Pick your favorite version of the same story. But there's a very big problem with that explanation. So if the rising dollar is really just about higher U.S. interest rates, why are short-term dollar markets increasingly hedging for lower rates? That's the contradiction everyone should be paying attention to because it isn't really a contradiction at all. The dollar is rising not because the world is confidently repricing U.S. strength, but because the global system is being hit by a dollar problem. And short-term rates are falling not because everything's fine, but because markets are beginning to price the fallout from that same problem. Energy shock becomes dollar shock. Dollar shock becomes macro shock. And macro shock forces, at the very least, central bankers to rethink their hawkish script. And that's exactly what we're going to go through today because, like I said, what's taking place at the front of the U.S. dollar interest rate market is remarkable, if not shocking. The real story is how all of these markets are saying the same thing from different directions. The global economy is being squeezed by higher energy costs, tighter dollar availability, and the rising risk that central banks, they are indeed about to trichet themselves right into another downturn. So let's start with Asia. When the dollar rises against Asian currencies, it's not some abstract financial market event. These countries import energy. They import commodities. Their companies borrow in dollars. Their banks intermediate dollar funding. Their trade systems run through dollar payments. So when the dollar goes up, that's the real economy taking that hit. In Japan, they're the most visible example because the yen always gets the headlines. Officials in Tokyo can talk about one-sided markets and speculative moves, disorderly trading, and whatever else they want. They can threaten to intervene. They can actually intervene. They can burn and flush tens of billions of dollars in reserves right on down the toilet, trying to push the dollar-yen away from whatever line they've decided is politically unacceptable. But the underlying issue is not psychology. It's not speculators. It is not the gap between U.S. rates and Japanese rates. Japan is a massive energy importer. When oil prices rise, Japan needs more dollars to pay for the same physical energy. If oil is priced in dollars, the price of oil goes up, then demand for dollars rises mechanically. The yen then weakens because the country needs more dollars than it did before. That's not a speculative story. It's just a balance of payments issue as just a start, as the basis. And it's not just Japan. South Korea has the same kind of vulnerability, though through a slightly different channel. Korea is deeply tied in global trade, technology exports, manufacturing, as well as imported energy. The yuan is one of those currencies that often behaves like a real-time barometer for global demand and dollar liquidity. When global trade looks shaky, when energy costs start to rise, when the dollar funding environment tightens, the yuan tends to feel it very quickly. And right now, the world is worried about demand destruction and what that might do to specifically Korea's export economy and the dollars it would have available locally. Then there's Indonesia. The rupiah is always watched for portfolio flows, foreign holdings, and the central bank's willingness to undertake emergency measures. In fact, just this past week, Bank Indonesia delivered an unexpected, unexpected 50 basis point rate hike to try and stem the record weakness in the rupiah. And spoiler alert, it didn't really do all that much. Indonesia has commodity strengths, yes, but it's still exposed to dollar funding conditions and imported energy pressures. If the dollar rises broadly, foreign investors become more cautious, local currency bonds become more vulnerable, and Bank Indonesia gets pushed into the same uncomfortable corner. Defend the currency, protect its reserves, and try not to tighten domestic liquidity too much. And then there's our old friend India. India may be the clearest example because the rupees pressure has already moved beyond the currency screen and into the trade system. When a country starts looking at gold and silver imports as a problem, that tells you this is not just about foreign exchange charts. It tells you officials are trying to conserve dollars. India can't stop importing oil. It needs energy to run the economy. But gold and silver? Those are politically sensitive and culturally important. Absolutely. But from the government's balance of payments perspective, they are discretionary dollar drains. So when India tightens import rules and raises duties, caps certain shipments, or pleads with households to avoid buying precious metals, that's not really a gold story. It is a dollar story. The public sees gold as protection. The government sees gold as dollar leakage. And that's exactly what happens in a dollar shock. It's playing out all over the map. Japan, South Korea, Indonesia, India. How about Turkey? The Turks were forced to sell all their U.S. treasury reserves because the dollar shortage hit them squarely in the currency and the economy. I almost never do ads. And I say no to the vast majority of those that are brought to my attention. But I was thrilled to be able to work with today's video sponsor, Monetary Metals. And the reason is because they're solving a big problem, one that I've been highlighting for a very long period of time. Gold is a safe haven. But other than sitting in a vault, it doesn't do anything. Monetary Metals fixes that. 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And you can tell during periods like this who is really in charge. So Japan threatens intervention. India supplies dollars. Indonesia leans against rupiah weakness. And Korea watches the yuan and talks about stability. Officials always claim they're fighting volatility or speculation. They almost never admit the real issue is the availability. The availability is important and price of dollars. But intervention does not create new global dollar capacity. It reallocates existing reserves temporarily, very temporarily. When a central bank sells dollars to support its currency, it is supplying dollars to the market that desperately needs them. That can slow the move of the FX market. It can scare off some leveraged traders. And it can generate a dramatic intraday chart. But it does not change the energy bill. It does not change the trade deficit. And it doesn't change private dollar funding conditions across the euro dollar system. It won't change the global macro shock. Worse, intervention has side effects of its own. If a central bank sells dollars and buys its own currency, it can drain local liquidity. That might tighten domestic money markets unless the central bank does something to offset it. So the country gets pressure from both sides, external dollar pressure and internal liquidity pressure. That's why interventions often have a shrinking half-life. The first one might shock the market. The second one already does less. By the third or fourth, traders begin to ask the obvious question. How much are they willing to spend? How much are they willing to set on fire and flush down the toilet? And what happens when they stop? And this is especially true when the underlying shock is energy-driven. If Japan, for example, spends billions defending the yen while energy importers still need more dollars every day, the pressure is going to keep coming back. If India sells reserves while oil and gold demand keep pulling dollars out of the country, the pressure is going to come back. If Indonesia defends the rupiah and raises its policy rates while global dollar funding continues to tighten, the pressure is going to come back. That's why these currency moves should not be dismissed as isolated foreign exchange events. They are symptoms of stress in the euro-dollar system, which brings us to what might be the most important and shocking part of all of this. What's taking place at the front end of U.S. dollar interest rate markets? Because the front end of the U.S. dollar interest rate markets appear to be seeing the same thing that we're talking about here across Asia. Now, everybody thinks it's set in stone. Central bankers are going to hike rates all across the world, even including the Federal Reserve. I mean, Christopher Waller, a well-known dove, has been talking about rate cuts all year for quite some time, going back to last year. Suddenly, he says, maybe our next move might be a rate hike. So everybody believes the next direction for central banks is rate hikes. It's done deal. It's going to happen. Well, it might happen, but markets are increasingly betting, if not hedging, for it to not happen. If you only look to the headlines, you'd think the entire interest rate market is screaming inflation. Oil is up. Gasoline is up. Headline CPI risk is up. Central bankers everywhere are talking tough again. So naturally, everyone focuses on the 10-year treasury and the two-year treasury and the latest speeches from policymakers. But the very front of the U.S. dollar curve is doing something far more interesting. As I said, shocking even. Treasury bill yields, they've been moving lower, lower. Terms SOFR had been drifting lower than this week. The one-month tenor just dropped as if there was a trap door. SOFR futures, especially the front part of that curve, they've been pricing a greater chance of lower short-term rates ahead. And that matters. Now, bills can move lower for a couple of different reasons. Sometimes it's collateral scarcity, as we know only too well here at Uridal University. When bills are in high demand as pristine collateral, investors accept lower yields on them because the security itself has balance sheet value. In that case, bill yields can fall even if the market is not expecting a change in Fed policy. So we can't look at bill yields alone. We have to compare them with other instruments. And that is where term SOFR and SOFR futures become important. If bill yields are falling but term SOFR stays firm, maybe the move is mostly collateral. But if bill yields are falling and term SOFR falls with them, then the market is not only paying up for bills, it's also beginning to price lower future overnight funding rates. That's a very different message. And it's especially important right now because the public narrative is still, as we know, dramatically hawkish. The mainstream is still obsessed with inflation. Central bankers are still talking about staying restrictive, restrictive with the scare quotes. Some are even attempting to height rates because energy is lifting the headline CPI. Yet front-end dollar markets are saying, not so fast. Now, they're not necessarily screaming immediate emergency rate cuts. This is not automatically a prediction that the Fed's going to slash rates at its next meeting. But they are hedging the possibility that policymakers will not be able to follow through on their hawkish script. They're pricing the risk that the economy weakens faster than central bankers expect. That is the Trichet risk. Now, Jean-Claude Trichet and the European Central Bank, they hiked into an energy-driven inflation shock in 2008 and again in 2011, right before the macro situation turned very ugly. They mistook an oil shock for durable inflation pressure. They responded to headline CPIs and ignored the recessionary impulse that was underneath the entire time. And that's the same danger that we have now. An energy shock can raise CPIs in the short run while also damaging the economy at the same time. It acts like a tax on consumers and businesses. It drains purchasing power. It worsens trade balances for importers. It tightens dollar liquidity, as we've been talking about here, weakening currencies. It forces central banks into defensive postures. That's not a classic demand-driven inflation boom. It's a squeeze, a short-term dollar squeeze and short-term dollar markets are beginning to price the squeeze and its broader implications. Now, this is the part that often confuses people because they're told that interest rates in the dollar are basically the same thing. When U.S. dollar interest rates go higher, the U.S. dollar exchange value could go higher too. So how can the U.S. dollar exchange value go up at the same time at least short-term interest rates and short-term forward rates are pointing down? Now, sometimes that's the case, but not during a dollar shortage. In a dollar shock, the dollar can rise even as rates markets begin pricing lower rates. That's because the dollar's not rising due to an attractive yield. It's rising because the global system needs dollars, like we went over. Think of it like this. If everyone wants dollars because they're confident in U.S. growth and higher returns, that's one kind of strong dollar, the one we haven't seen in a very, very, very, very, very long time. But if everyone needs dollars because trade payments and energy bills, debt service, margin calls, and funding obligations are all becoming more difficult, that's a completely different kind of strong dollar. The first version would be risk-on. The second one is all about stress. And right now, Asian currency weakness is very clearly the second version. Japan doesn't need dollars because America's booming. It needs dollars because oil is expensive and Japan imports energy. India does not restrict gold payments because U.S. yields are attractive. It restricts gold imports because gold purchases drain dollars while the oil bill is already rising. Korea's won does not weaken simply because of carry trades. It weakens because the global trade cycle and dollar liquidity are turning more and more hostile. Indonesia's rupiah does not come under pressure only because of Fed rhetoric. It comes under pressure because global investors, commodity flows, and dollar funding conditions all tighten together. Meanwhile, U.S. short-term rates fall because the market sees the other side of that same shock. If energy prices stay high, consumers everywhere, not just in Asia, consumers everywhere get squeezed. If Asian currencies fall, import costs rise and regional demand weakens. If central banks defend currencies and local liquidity tightens, if dollar funding gets harder, global trade and credit suffer. If the macroeconomy worldwide takes the hit, the Fed eventually can't stay hawkish. So the dollar rises now because the system needs dollars. Short-term rate expectations fall because the same dollar shock increases recession risk. That's not a contradiction. It is the signal. Now, the markets are not saying that energy prices don't matter for what everybody terms inflation. They do, obviously. CPIs have already gone up in some places, though some CPIs are moving lower. That's a separate topic for another day. So it's, you know, consumer price rates are going to be infected in the short run by what's taking place in the energy market. That part is, that's where central bankers and the markets differ. Central bankers believe that oil prices rising can lead to second-order effects that become a runaway spiral of inflation. What the markets are saying is that ain't how this works. And historically speaking, what happens is rising energy costs lead to all of these other nasty consequences in dollar funding markets, as well as the macroeconomy, that lead to eventually rates going down. Different sides of, I hate to say it, the same coin. Because the question is always about sustained inflation or whether this becomes that macro shock. And the evidence continues pointing toward the macro shock. And we've gone over a bunch of it just this past week, all over the world, including the United States. And Steve and I are going to cover the signals that are coming from Europe in tomorrow's video. Well, it looks more and more like the macro cliff. But if this was a true inflationary boom, you would expect broad confirmation. You would see rising long-term inflation compensation in the TIPS market. Talk about that one. A more aggressive repricing of real activity in front-end dollar markets leaning harder into higher policy rates. Instead, we've got something else. We've got energy prices that are causing immediate pain. We've got Asian currencies that are weakening under dollar pressure. We've got governments intervening, restricting imports, and trying to conserve their reserves. And we have short-term U.S. dollar markets that are increasingly pricing the possibility, the possibility the next move from the Fed is down, not up. That together is a hurricane warning. Not because everything collapses tomorrow. That's not the point. That's never the point. The point is that markets are beginning to recognize the policy trap. Central banks see higher headline CPIs and they want to sound tough. However, if they ignore the currency pressure and import prices rise, if they defend the currency and burn through reserves and tight liquidity, if they restrict imports, all they're really doing is revealing the stress. That's why the combination of a rising dollar and falling short-term dollar rate expectations is so critical. It tells us the market is looking past the headline CPI and toward the economic and monetary damage underneath. So watch the Asian currencies. Watch dollar-yen, Korea's won. Watch the rupee and especially our old friend, India's rupee. Pay close attention to what India is doing with gold and silver imports. Make sure you know how often Japan threatens intervention and then carries it out. Keep a close eye on reserves and trade deficits, oil prices and funding markets. But keep a closer watch on the very front of the U.S. dollar curve. Watch treasury bills, scrutinize term SOFR, analyze the shape of the frown on term SOFR futures. Because if the dollar keeps rising while short-term dollar rates keep falling, that's not a vote of confidence in the U.S. economy or the global system. It's a warning that the global system is being squeezed. Energy shock became dollar shock, dollar shock becoming macro shock, and therefore central bankers realizing belatedly that headline inflation from oil is not the same thing as lasting inflation. In fact, it's the last thing you see before the global economy rolls all the way over. Yes, we're seeing the macroeconomic shock pressures here in the United States too. We got warnings this week from Lowe's and Kroger and Walmart and S&P Global. Those are all in the video link below. As always, thank you very much for joining me. Huge thank you, your Rhode Island University members and subscribers. And until next time, take care.