US Dollar: Time to Worry ?
City Index August 8, 2013 10:28 PM
<p>Four weeks ago, the USD index hit 3-year highs, metals licked their wounds from the biggest decline in decades and the US growth story stood […]</p>
Four weeks ago, the USD index hit 3-year highs, metals licked their wounds from the biggest decline in decades and the US growth story stood out in the headline. The Fed was considered the only major central bank capable of scaling down its quantitative easing, while the ECB mulled cutting interest rates to zero. The greenback was boosted by a powerful combination of fundamental and technical moving in tandem.
But all changed in June when the Fed reminded that any tapering of asset purchases would not necessarily tighten monetary policy as persistent growth in the Fed’s balance sheet would help maintain liquidity driven in the markets.
The Fed’s statement was not isolated. Signs of stabilization in the business surveys of the Eurozone and the UK PMIs as well as market scepticism with Japan PM Abe’s “policy arrows” conspired to rebalance the flows in currency markets.
The timing of the aforementioned dynamics is never a coincidence. From a charts perspective, the greenback had tested an 8-year trendline resistance (see chart), EURUSD tested a 12-month trendline support and the yield on the US 10-year government note tested its 6-year trendline.
Where to Watch?
The list of explanations can go further and so do the plausible scenarios for a continuation of the USD’s downtrend as well as its recovery. As it stands, we expect further strength in both the yen and sterling against the USD into the rest of the month until the USD index retests its 2-year trend support at 80.40-45. This implies an equivalent resistance near 1.3450s and 1.5660s in EURUSD and GBPUSD respectively.
What to Watch
Once these currency parameters are attained, the commentary from the Fed will once again be scrutinized as we near the revision of US Q2 GDP, the release of the August jobs report and the Fed’s annual symposium in Jackson Hole, all taking place in the final week of August/early September. The fundamental scenarios for a break in USD support could well include a lower than expected tapering of the $85 bn in asset purchases, or no tapering at all in September but only a mild announcement for December. And do not discount the role of the obligatory article from Wall Street Journal’s Fed watcher Jon Hilsenrath, whose effectiveness in steering bond and FX markets has returned after a temporary lull late last year.
On the fiscal side, FX traders will closely watch President Obama’s corporate tax reforms and the possibility of slashing taxes on US multinationals’ foreign earnings. When Bush introduced similar reform in 2004 as part of the Homeland Investment Act, the dollar had a powerful year resulting from US multinationals repatriating nearly half a billion dollar to qualify for the tax holiday in 2005.
We have not covered non-US factors, which could stem the tide of USD-negative FX flows such as; negative surprises from China’s macro data/money markets; rising pre-election tensions in the camp of German Chancellor Merkel and unforeseen finance shortfalls from the sovereign obligations of Southern Eurozone nations. These are the factors to watch and the levels to scrutinize?
StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.