The US bond and stock markets continued their rally, propelled by soft US economic data and robust bond auctions. The US dollar experienced a sharp decline against major currencies, including the euro, sterling, and the yen, as the year-end approached. However, concerns are emerging that the rally in sovereign assets and the subsequent stock surge, along with the dollar’s sell-off, may be overextended. As euphoria continues, there is a rising risk of a significant correction.
The week’s economic calendar, though not heavy, has provided fuel for Federal Reserve (Fed) doves. The Richmond Manufacturing index released on Wednesday indicated a faster-than-expected slowdown in economic activity in December, contributing to the dovish sentiment. Another strong US bond auction reinforced the conviction of investors, with the 5-year yields falling to 3.80%, 2-year yield sinking to 4.23%, and the 10-year yield dipping below the 3.80% level.
The US dollar index fell below 101 due to the accelerated drop in sovereign yields, pushing the EURUSD past the 1.11 mark. Cable (GBPUSD) surged above 1.28, while USDJPY eased to 141.
However, concerns are mounting that the recent easing in US financial conditions, driven by the impressive sovereign rally, may be excessive. The US has witnessed the most significant two-month easing in financial conditions in its history, raising questions about its sustainability given geopolitical tensions that could disrupt global trade and potential inflationary pressures.
Despite oil’s brief rise above $76 per barrel due to Red Sea tensions, it quickly snapped back below $74 per barrel, providing some relief.
As the euphoria in the markets persists, there is a cautionary note about the potential for a wild correction in the US dollar when the current optimism comes to an end.