By Marc Chandler of BBH FX Strategy

NEW YORK ( TheStreet)-On the heels of the healthy March jobs report and new cyclical highs for the manufacturing and service sector ISM surveys, the market moved to fully discount a 25 bp rate hike at the November Federal Open Market Committee (FOMC) meeting. This was evident in the Fed funds futures strip and the OIS/Fed funds rate. The market has backed off slightly today.

U.S. interest rates have eased today, with coupon yields slipping 3-5 bp, perhaps on some bargain hunting after the 10-year yield reached 4% yesterday. Perhaps U.S. debt is also picking up a safe haven bid, given the blow out of Greek credits today.

Nevertheless, there has been a sharp backing up of U.S. interest rates in recent weeks. There are two components to interest rates. There are the real rates and the inflation premium. In some ways the inflation premium is easier to estimate and the residual would be the real rate.

One estimate of the inflation premium could be derived from the 5-year/5-year forward. Both the Fed and ECB have in the past cited this as one of the measures it looks at for inflation expectations. In the U.S. this rate is now about 2.58%. This represents a little less than a 20 bp increase since late February, which was the low point thus far this year. However, that increase seems to be simply noise as the 100-day moving average is near 2.63%. The recent high was set in early February just above 2.8%.

By contrast, the U.S. 10-year yield now at 3.94% is well above its 100-day moving average or 3.45%. It appears that the bulk of the increase in nominal U.S. interest rates reflects an increase in real rates rather than the inflation premium. Two considerations seem behind the rise in real yields--supply and stronger growth--and it is difficult to estimate the relative importance of each of these considerations. Subjectively, it would seem like supply is playing a bigger role than increased demand for investment capital.

The U.S. dollar/yen exchange rate is particularly sensitive to interest rate movement. Year to date, the correlation (daily percentage change) between U.S.-Japanese 2-year rate differentials and dollar-yen is 65% and the correlation at the 10-year level is about 72%. In 2009, the correlation coefficients stood at .427 and .436 respectively.

Our work does not show a similar relationship between U.S.-German rate differentials and the euro. Indeed, the yen is more correlated with the U.S.-German interest rate differentials than the euro is (U.S.-German 10-year differentials and the dollar-yen are 57% correlated this year vs. almost 9% for the euro). However, in terms of interest rate differentials, the euro appears to have a tighter correlation with the very short-end. We found the euro's correlation with the spread of the second Eurodollar and Euribor contracts (that would now mean the Sept 10 contract) was about 34.5%.

---Written by Marc Chandler in New York.
Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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