G10 FX Weekly – Dollar sell-off

by: Georgette Boele , Roy Teo

  • Dollar aggressively sold off because of weak cyclical forces and a change in investor sentiment
  • The Swedish krona outperformed on less aggressive monetary policy stimulus
  • Our new forecasts reflect the recent dollar weakness, which we expect to be temporary


 

Dollar sells off…

Last week, we expressed our view that stronger-than-expected US data and a less dovish Fed could be triggers to restart the US dollar rally. However, the opposite has happened. Indeed, the dollar was the worst performing major currency this week losing between 1-4%. What has gone wrong?

 

…because  weak cyclical forces weigh on the dollar…

US GDP for the first quarter was dreadful and this triggered significant dollar weakness. The US Federal Reserve sounded neutral, but financial markets are confident that it will not hike interest rates while the economy is weak. As a result, financial markets have further priced out rate hikes this year and next year. They expect the Fed funds rate to be at 0.34% at the end of 2015 and at 1% at the end of 2016. This is far below the Fed’s own projections and our expectations. As these cyclical forces weigh heavily on the dollar, it is not a surprise that EUR/USD moved above 1.10 again. Going forward, we expect  a strong rebound in US economic growth which will seal the case for a start of the rate hike cycle in September 2015.

 

…while risk aversion trades are being unwound

In addition, investor sentiment in financial markets has improved dramatically. This was reflected by investors moving out of eurozone and US government bond markets. The euro profited strongly from these developments because financial markets also seem to have become less concerned about Greece. The anti-risk aversion trade explains why safe haven assets such as gold and the yen have barely profited from the weakness in the US dollar.

 

The Swedish krona outperforms G10 FX

The Swedish krona has outperformed other major currencies this week, because the Riksbank eased monetary policy less aggressively than had been anticipated by financial markets. The Riksbank increased government bond purchases, but left the repo rate unchanged at -0.25%. Financial markets had expected a cut to -0.35%. Going forward, we expect further monetary policy easing to push up inflation and to avoid an appreciation in the Swedish krona.

 

Forecast adjustments

We have made some adjustments in near-term forecasts to reflect the recent wave of US dollar weakness. However, we remain confident in our calls : 1) a strong US economy, 2) Fed starting the hiking cycle in September, 3) Fed funds to reach 0.75% at the end of 2015 and 2.25% at the end of 2016 4) The Bank of Japan to ease monetary policy in July to support the economy and to bring inflation closer to its target 5) Election uncertainty to weigh on sterling in the coming months. Our adjustments are highlighted in the table below. We have also brought our EUR/USD forecasts for 2016 more in line with our bond yield forecasts.