US Dollar: Inflation expectations support USD and Treasuries

⦿ 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.

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.

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.

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.

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.

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.