Dollar jumps and oil sinks; bond market pays the price

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The Bush administration and the Federal Reserve are getting what they wanted: a big rally in the dollar and a drop in oil prices.

But the cost is higher interest rates -- great for savers, lousy for home buyers.

The dollar has jumped today to a three-month high of 107.37 yen from 106.10 on Monday, while the euro has fallen to $1.545, down from $1.565 on Monday and from $1.577 on Friday.

Crude oil was off $3.12 to $131.23 a barrel at about noon PDT, after rising as high as $137.98 early in the session.

Let’s recap the last few days: Oil soared to a record high of $138.54 a barrel on Friday, in part because the dollar slid and the stock market dived after a disturbingly weak U.S. employment report for May.

Here’s the widespread view on Wall Street: The administration and the Fed looked around for a way to help pull oil back down, and they decided to focus on the dollar. If they can boost the greenback’s value they might reduce global investors’ and speculators’ appetite for commodities, which have been rallying in part because a weak dollar makes commodities look more appealing than other dollar-denominated assets.

So early on Monday Treasury Secretary Henry M. Paulson Jr. tells CNBC that the administration won’t rule out jumping into the currency market to boost the dollar.

Fed Chairman Ben S. Bernanke follows that with a speech Monday evening in which he basically says the economy will be OK, and the Fed is more worried about inflation. The hint therein: The Fed’s next step with interest rates is more likely to be an increase than a cut.

Today, yields on Treasury bonds are surging on Bernanke’s warning. The two-year T-note yield was at 2.90% at about noon PDT, up from 2.71% on Monday and 2.38% on Friday. That’s a massive move in two days.

And as U.S. bond yields rise, that underpins the dollar’s value by making bonds more attractive to global investors.

‘What Bernanke has done to U.S. yields has given the dollar a lot more support than anything else he could have said,’ said Daniel Katzive, a foreign exchange strategist at Credit Suisse in New York.

But rising bond yields will put upward pressure on mortgage rates, too -- which is about the last thing the crippled housing market needs.

Wall Street ought to know better than most: There is no free lunch.