US Dollar: Inflation expectations support USD and Treasuries – BNY

⦿ Executive Snapshot

• What: BNY's Geoff Yu discusses how U.S. long-term inflation expectations are aligning with Europe’s, which supports the U.S. dollar and Treasuries.
• Who: Geoff Yu, BNY analyst, and U.S. investors and external bond managers.
• Why it matters: The convergence of inflation expectations could lead to increased investment in U.S. Treasuries, impacting the dollar's strength and market dynamics.

⦿ Key Developments

• U.S. long-term inflation expectations, as measured by 5y5y swaps, are rising and catching up with Europe’s levels due to market pricing of prolonged disruption risks.
• Yu forecasts a potential 10bp upside in inflation expectations as they converge with Eurozone levels through the second half of the year.
• The U.S. has experienced a significant rise in real yields, making U.S. Treasuries more attractive to both onshore and external investors, despite inflation expectations.

⦿ Strategic Context

• Historically, U.S. inflation expectations have been lower than those in Europe, but current data suggests a shift that reflects changing economic conditions and investor sentiment.
• The ongoing geopolitical situation and its impact on energy markets and trade dependencies are critical in shaping inflation expectations on both sides of the Atlantic.

⦿ Strategic Implications

• The immediate consequence of rising real yields is an increased attractiveness of U.S. Treasuries, likely leading to higher capital inflows from both domestic and international investors.
• In the long term, sustained inflation alignment between the U.S. and Europe may signal a shift in global investment strategies and monetary policy considerations.

⦿ Risks & Constraints

• Potential regulatory changes or shifts in monetary policy could alter the current trajectory of inflation expectations and real yields.
• Competition from European bonds could hinder the U.S. dollar's strength if their yields become more attractive relative to U.S. options.

⦿ Watchlist / Forward Signals

• Monitor upcoming U.S. economic data releases that could influence inflation expectations and Fed policy decisions.
• Watch for shifts in external bond manager sentiment towards U.S. Treasuries as savings levels and trade surpluses evolve in the coming months.