The FT — among many others — seems to have called the bottom of the dollar cycle with its Thursday report citing “senior officials” in the US and eurozone agreeing - far more emphatically than they have in recent months - that enough is enough and it’s time for the dollar to strengthen.
The US currency at one point on Wednesday rallied to a six-week high against the euro; the pound is looking more lacklustre than it has in a long time against the dollar and in Asia, carry-traders are licking their chops amid predictions of further yen weakening. The question is whether the dollar rally has been overdone, or if not, how sustainable is the currency’s new display of strength?
From the pile of analysts’ notes before us, we can say opinion is divided - although it leans more towards the view that for now, anyway, the dollar is on the way up, the euro is heading for a retreat, sterling is not looking good at all, and the yen is entering a period of weakness.
As Richard Grace, forex strategist at Australian bank CBA, warns, the US dollar has traditionally displayed a tendency to “bump along the bottom” for a number of months before a major turning point in the cycle develops. This time, he says, the cycle is likely to be no different because, first, there’s still a “significant risk” of more weak real US economic data, and, second, there remains a significant amount of sovereign interest in the euro.
Consequently, he concludes, hedging the turn of the USD cycle would be wise - despite the bias leaning toward further dollar strength.
On dollar-yen, meanwhile, Grace brings good cheer to carry traders, noting that various indicators suggest “conditions are ripe for USD/JPY to press higher” and could even see the yen test Y108 from the current level around Y104.50. On the popular AUD/JPY trade, Grace’s exchange rate model is “singing the same tune”, he says, suggesting further upside in AUD/JPY.
The only “minor alarm bell ringing” on long USD/JPY positions, says Grace, is the tendency for something to “come out of left-field and whack USD/JPY lower” as soon as the market gets relatively complacent about the downside risks. Pinpointing that catalyst is difficult - hence, advises Grace, one should remain cautious and be prepared to cover net long USD/JPY positions with some insurance.
The fundamental outlook for the Aussie dollar, meanwhile, remains good and you can expect some strengthening of the currency. Any unexpected surprise strength in the US dollar will result in greater weakness in the euro, pound and, to a lesser extent, the yen, rather than in AUD weakness, due to the stronger domestic fundamentals supporting the Aussie.
Meanwhile, the team at Gavekal, the HK-based outfit, says in a note that it likes to think that currencies trade based on a) fundamentals, b) valuation and c) momentum — usually in that order. Hence, its assessment of where the dollar stands today:
1) Fundamentals: The sub-prime fiasco and the subsequent credit crunch has, obviously, weighed negatively on the US$, along with widespread expectations that the US was heading for a recession. Increasingly, however, it looks like the US will escape the fate of recession. In contrast, recession fears are starting to creep into the dialogue on the EU outlook with some lacklustre figures out from Germany, UK and regional retail sales.
2) Valuation: Based on purchasing parity, the USD has never been more undervalued against the euro. Moreover, the Fed is likely to have come to the end of its easing cycle, while there is increasing pressure on the ECB to soften its hawkish stance — in Thursday’s meeting, it is expected to keep its lending target on hold at 4%.
3) Momentum: The dollar is up 3.4 per cent on a trade-weighted basis since its recent low on April 22. But it is up 4.2 per cent against the euro and appears to be strengthening more against the euro than against other major currencies.
If a stronger dollar-trend proves to be “more than a twitch”, then this should help to deflate the ongoing commodity bubble, the note concludes. Moreover, an expected decline in commodities demand from China as the Olympics comes and goes, could also take some pressure off. If this scenario unfolds, then it would be extremely bullish for Asian equities, which have been struggling under the fear of never-ending margin squeeze and runaway inflation.
Finally, Ashraf Laidi, chief FX analyst at CMC Markets, believes downside in the euro is more durable as a result of weak European data rather than strong US figures. Expect the euro to lose further ground, he says, testing last week’s $1.5360 lows, followed by $1.53 later in the month — Laidi’s month-end forecast. Sterling, meanwhile, is also expected to lose further ground, with a month-end forecast of $1.9450, followed by $1.90 for Q3.
As for yen-dollar: the dollar’s recent recovery against the yen was mainly courtesy of EUR and GBP weakness, fuelling the greenback across the board with the exception of the Canadian dollar. Laidi, too, predicts further strengthening of the US dollar, breaching Y105.70 for medium term resistance at Y106.30 for the reminder of the month — but it ends there, he says, where a turnaround is due back towards Y103.
Expect, also, further USD declines versus the commodity currencies of Australia and New Zealand as inflation and renewed composure in commodities will continue to favour the high-yielding currencies until mid-summer, when the slowdown becomes more pronounced and you might see a global retreat in US and world equities.
