The dollar seems to be bouncing back from its lows last week, due partly to better-than- expected US jobs data last Friday – (despite continuing growth in the overall US unemployment rate) - which fuelled speculation that bearish sentiment towards the US currency might be abating.
The jobs data followed a week in which various Asian countries gave nicely reassuring indications about supporting the dollar’s continuing role as a key currency. So this time around, analysts and commentators are suggesting that the US currency could sustain its current trajectory. Is it likely?
As the FT reports, the dollar over the past week rose 1 per cent to $1.3980 against the euro, climbed 2.3 per cent to Y97.54 against the yen, gained 1.7 per cent to SFr1.0852 against the Swiss franc and rose 0.8 per cent to $0.7959 against the Australian dollar. This is after it hit a fresh low for the year on a trade-weighted basis last Wednesday, weighed down by ongoing concerns over the US government’s finances and improving risk appetite. Reports the FT:Analysts said that improving sentiment [about the economy] prompted investors to abandon the relative safety of the dollar in search of yield, especially in commodity-linked currencies. Indeed, the dollar fell to a low of $1.4337 against the euro on Wednesday, its weakest level so far this year and also dropped to $0.8263 against the Australian dollar, its lowest level since the collapse of Lehman Brothers last September.But the dollar recouped its losses when US jobs data came in better than expected. US non-farm payrolls fell by 345,000 in May – this was far better than the consensus forecast for a 520,000 drop and the smallest fall since September. Analysts said the fact that the dollar rose after the jobs data, rather than retreat as risk appetite picked up and investors abandoned the US currency in search of yield, meant the tide could be turning in its favour.
As CMC Markets’ Ashraf Laidi notes, wild forex volatility stemmed from the huge disparity between the soaring unemployment rate and improved payrolls, as the reports failed to convince currency traders of sticking with singular USD-trades.
Initially last Friday, bond yields soared by 20bps to 3.90 per cent, equities rallied and the dollar dropped sharply on the jump in appetite as markets focused on the smallest US job loss in eight months (-345,000 against expectations of -530,000), while shrugging the 0.5 percentage point jump in the unemployment rate to 9.4 per cent – the highest since 1983.
But, he adds, “such a sharp disparity between soaring unemployment rate and improved payrolls, risks dampening the aggressive rally in equities as both the establishment and household surveys of the US Bureau of Labor Statistics report lack the necessary job creation required for to maintain the +40 rally in equities from their March lows”. Here’s more from Laidi:
Although equities remain in the green for now, currencies are curtailing the initial risk-trade by scalding down the initial losses in the dollar. EUR/USD, GBP/USD plunged nearly 200 pts in less than 10 minutes, prompting a $25 decline in gold to $955. FX markets have seen such moves in the past, as “real money” accounts seek to book rapid profits in uncertain markets, especially when US equities post their biggest recession-period percentage gain. Since the 1950s, the S&P500 has never rallied by as much as 40% in a recession. This implies that equities could be increasingly vulnerable to a retreat. We also maintain our view that the record-breaking 10-2 year spread at 277bps is unlikely to abate without more aggressive treasury Fed purchases.
CLSA’s Christopher Wood goes further, warning that the decline in the US dollar index (which measures the value of the dollar against a basket of foreign currencies, namely the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona) is one macro risk that potentially threatens stock markets in the short term. The index is now around the same level where it found support in December last year, Wood noted in his weekly client newsletter Greed & Fear last Friday:The index fell to an intraday low of 78.3 on Tuesday and closed at 79.5 on Wednesday. If the index breaks this key technical level convincingly and its decline proceeds to accelerate, then a collapsing dollar could become a major negative for equities in stark contrast to the gently declining US dollar which has been a bullish driver for equities, particularly Asian equities, in recent months… The current psychology in world stock markets is clear. A growing number of markets have returned to their pre-Lehman levels in mid September 2008, and those that have not have room for more “catch up”.
Such a psychology could keep driving the S&P 500 higher in the short term, towards Wood’s 1,000-1,050 bear market rally target, he says, “just as it can also drive stocks in Asia higher which are still below pre-Lehman levels”.
A tanking dollar of course could damage such a rebound. But don’t expect this full-scale dollar collapse to happen now, adds Wood:
Rather the view here remains that the collapse comes later and that the recent dollar decline reflects renewed risk appetite causing the dollar to become the funding currency of choice for a new carry trade. This also suggests that the dollar will be due a decent rally when equities correct. Still the dollar collapse risk must be noted [last week] given the currency’s decline to a key technical level. A dramatic decline in the dollar, as opposed to a gradual depreciation, could in no way be viewed as positive for equities since it would signal a loss of independence for US monetary policy.
On Monday, however, the index rose 0.6 per cent to 81.129, according to Bloomberg, as Brazil, Russia, India and China increased foreign reserves by more than $60bn in May to limit currency gains amid falling exports:
While Russian, Chinese and Brazilian leaders suggest substituting the dollar, the central bank purchases show just how dependant they remain on the world’s reserve currency. Russia is proposing the BRICs consider creating a new unit of exchange when they meet in Yekaterinburg on June 16. China and Brazil said last month they may look at ways of dropping the dollar for trade between the two countries.
But ultimately, “foreign central banks do not want to see their currencies relentlessly strengthen,” Daniel Tenengauzer, head of foreign-exchange and emerging-market debt strategy at Bank of America-Merrill Lynch told Bloomberg. “Such a move would dampen an already-weak outlook outside the US and potentially risk even more capital-markets chaos if the dollar appeared to be heading toward a disorderly decline.”
Finally, just returning to the issue of US jobs – or any other data – driving the currency one way or another: perception, of course, can be as important as reality when it comes to factors that move markets. But LearningMarkets points out, in a post entitled “The truth behind unemployment reports”, that US unemployment figures that can influence traders’ decisions- whether in the forex, equity or any other markets- can be highly questionable. The main lesson for traders is that they should draw conclusions from this news “at their own peril”.
Related links:
Dollar gains as bears back off – FT
Dollar gains against euro as traders bet rates to rise – Bloomberg