FX Comment – China FX move hurts US dollar

by: Georgette Boele

  • China FX move hurts US dollar…
  • …because of some deterioration in sentiment…
  • …and scaling back of expectations about a possible rate hike in September
  • We continue to expect the Fed to start raising rates in September and the US dollar to rally

China’s FX move has negatively impacted the US dollar. There are two reasons for this. First, as recent episodes of deterioration in investor sentiment have shown, the US dollar is negatively affected because it is mainly driven by cyclical forces such as the state of the US economy and Fed rate hike expectations. Second, financial markets have slightly scaled back expectations about a possible rate hike in September because of concerns about China. We do not share this view. Chinese authorities are working hard to support the economy, which is logical. A weaker US dollar has supported gold prices.

We expect that the US economy will strengthen in the months ahead. This will also trigger a Fed rate hike in September in our view. Currently, money market futures have not even fully priced in one rate hike. We expect two rate hikes this year. This, and the upward adjustment in interest rate expectations for 2016 should give a strong boost to the US dollar this year. We expect EUR/USD to test parity in the coming months mainly because of the monetary policy divergence between the US and eurozone.