FX Weekly – Dollar still under pressure

by: Georgette Boele , Roy Teo

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The FOMC monetary policy decision on 18 March has continued to have a negative effect on the US dollar. Over recent days, though, the impact is easing. Another factor that has resulted in a recovery in EUR/USD is stronger eurozone economic data. Moreover, a deterioration in investor sentiment triggered higher oil prices and demand for safe haven currencies. Currently, the US dollar is not among those safe haven currencies. Subsequently, an improvement in investor sentiment gave some room for the dollar to recover. Next week, US labour market data will take centre stage. Strong data will continue to support the US dollar going forward as well as underlining the outlook for further monetary policy divergence.

FOMC decision still being felt…

Since the FOMC meeting, the US dollar has been clearly out of favour. This is because of the message that rate hikes by the Fed are not imminent and the hike cycle will be slow once it starts. This week, the sentiment for the US dollar deteriorated further. There are a number of factors that explain this. For starters, eurozone economic data surprised the market positively, for instance eurozone PMI data and German Ifo. Therefore, financial markets no longer doubt a recovery in the eurozone. As a result, the euro rose. The EUR/USD moved from time to time above 1.10. The strength of the euro indirectly hurt the dollar as the euro is an important component in the overall US dollar index.  In addition, US economic data came in weaker. This resulted in lower expectations of investors about the US economy.

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…and sentiment deteriorated

Last but not least, investor sentiment deteriorated, because of developments in the Middle East (the airstrikes on Yemen). This pushed oil prices higher and also currencies of oil exporting countries such as the Norwegian krone and the Russian ruble. In addition, safe have currencies such as the Swiss franc and the Japanese also did well. Often the US dollar is also considered as a safe-haven currency. However, this is not always the case. There are periods that the US dollar’s performance is more closely linked to the state of its economy and the action of its central bank. Currently, we are in such period. Therefore, the US dollar has been negatively affected when investor sentiment has turned negative. There is one major exception to this. Risk aversion will only hurt the US dollar up to a certain intensity. When risk aversion goes global and financial markets fear a systemic or liquidity break-down, the US dollar will be frantically sought after.

…but some dollar recovery during the week

During the week, investor sentiment improved and this had a positive impact on the US dollar. This was also reflected in a rise in US 10y Treasury yields and lower gold prices. Next week, US labour data and ISM take centre stage. US labour market data are likely to remain strong, but this is in line with expectations. Therefore, a sharp rise in the dollar is unlikely, unless financial markets start to doubt the strength of the eurozone recovery again. Looking ahead, we remain of the view that EUR/USD will move lower. The aggressive QE programme by the ECB will continue to push lower eurozone yields and the euro. In addition, strong US economic data will warrant a 25bp rate hike at the September Fed meeting. Furthermore, financial markets will adjust to factor in more Fed rate increases this year and next year. This is a major positive driver for the US dollar.

Gains in NZD and AUD to trigger response from central banks

In the past week, the Australian (AUD) and New Zealand dollar (NZD) recovered as yield seeking investors returned. It is likely that current levels in the New Zealand dollar will trigger currency intervention by the Reserve Bank of New Zealand to weaken the currency.

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We are also of the view that the recent recovery in the Australian dollar is not being supported by economic fundamentals. Since the Reserve Bank of Australia (RBA) cut the official cash rate by 25bp on 3 February, the divergence between iron ore and coal prices and the Australian dollar trade weighted index has widened. This is likely to result in a more dovish stance by the RBA next month. Indeed, financial markets have priced in a 60% probability of a 25bp rate cut on 7 April, compared to under 30% chance one week ago. We do not think that any gains in the AUD/USD above 0.79 are sustainable.

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