The Dollar has been experiencing some love coning into the new year, with the DXY up just under 1%. However, is this just a technical rebound, or is there substance for a further rally?
The DXY is currently in a zone where the Dollar has historically consolidated before making a move lower or higher, evidenced by its price movement earlier in 2018. This historical pattern was also prefaced by a strong move downward from all-time highs, which we are currently seeing. This makes sense, as strength in the Dollar usually comes from a sharp exit out of risk assets and more stable assets such as the Dollar.
Before the end of 2014, the DXY struggled to clear 88 after ten years of relative dollar weakness. Coincidentally (or not), this was also the ten year period where the NASDAQ stayed below its all-time high during the bubble of the 2000s. However, once equity markets started their legendary rally in 2013, the Dollar soon followed. It seems like the Dollar follows US equity markets in a laggard fashion due to investors buying into hot US equities after they start to become expensive. Assuming you’re bullish on equity markets, are we going to see a yearlong bull run in the US dollar?
I have stated before that the Dollar has some fundamental headwinds such as Inflation, Quantitative easing, Low-interest rates, and an appetite for assets such as Gold. But these headwinds are irrelevant if global investors increase their appetite for US equities. However, institutions are ratcheting their bets against the Dollar, which has brought bets against the US dollar to an all-time high.
Vasileios Gkionakis, head of currency strategy at Lombard Odier, stated that “The speculative community is very short right now, but there is a good reason: because fundamentals still point to a weaker dollar in the medium term,” stating that the Democratic Party’s 1.9 Trillion Stimulus will push the Dollar down.
Speculate bets against the Dollar may induce a short squeeze if overseas investors plow their capital into US equity markets.
The dollar has fallen from grace from the peak of the Coronavirus. The dollar index is down 10% from its yearly high in March, where traders and investors went to cash.
However, with two strong positive results from two vaccine makers Pfizer and Moderns with their 90% efficacy with their vaccine trial, solid news on when we will get a vaccine will solidify a bull trend and a rotation into value and cyclical stocks.
Calvin Tse from Citigroup wrote in a report, “Vaccine distribution we believe will check off all of our bear market signposts, allowing the dollar to follow a similar path to that it experienced from the early to mid 2000’s.”
We can see that the US dollar has played well around the Fibonacci levels from April 2018 to its high early this year. It is currently sitting at the 78.6 % retracement, looking for targets at the 100% retracement and 168.1%., a full 20% drop.
As we saw at the start of the year, the rally was on extreme risk-off sentiment. Therefore, history suggests that we will only see a strong spike in the US dollar if there is risk-off sentiment, which is unlikely. We should also see some strength in the US dollar once the Federal reserve lifts quantitative easing.
Tse further stated, “There is plenty of reason to be optimistic” on the vaccine, and that the distribution “will catalyze the next leg lower in the structural USD downtrend we expect.”
Mark McCormick, global head of FX strategy at TD Securities stated that "It's likely, short term, [that] the US dollar trades lower on the easing of geopolitical uncertainty", citing that Biden is likely to back away from Donald Trump's confrontational and "America First" trade policy.
What are your thoughts on the US Dollar?
A revival of the Dollar? As we get closer to the election, investors and traders can see one thing in the future – uncertainty. Therefore, we can see market participants start preparing for the unknown.
As debates and the election come up, statements will be said, and policies will be announced to sway the markets significantly. Over the past five days, the Dollar index has rallied 1.28%. The demand for the Dollar may be pointed to investors and traders building up a cash position in their portfolios for two mains reasons
• To take advantage of significant markets swings; and/or
• Want to hedge against market slumps
Many institutional firms are backing the recent rally in the Dollar. Franseca Fonsari, head of currency solutions at Insight Investment, pointed to the election having the "potential to be a significant market mover" and that it would "probably [be] wise" to run lower levels of risk.
Furthermore, Shahab Jalinoos, Head of Currency Strategy at Credit Suisse, echoed Fonsari's comments. He stated that the U.S. election is a key risk that his team considers in predicting a stronger dollar. It is important to note, Shahab has been a bear for the U.S. dollar near the start of August – a point in the dollar decline where it had already depreciated around 7%.
Another currency strategist at Bank of America, Ben Randoll, also pointed to the "substantial economic and event risks ahead" and that he expects a "dollar rally into the election and possibly beyond."
As you can see – analysts are quick to turn their opinion around on a recent turn of event. All three analysts point to the election being a catalyst for the U.S. dollar while remaining bearish viewpoints before the rally. However, it has been clear for quite some time now that the election will be upcoming. Therefore, this is an excellent example of constructing your own analysis and validifying that analysis using technical and fundamental analysis. It's obvious to call a bull run when you're already in one.
I talked about the Dollar earlier this month, and how long term trends such as Inflation, Federal Reserve's Q.E., low-interest rates, and Gold's rise are headwinds pushing the Dollar further downwards. I stated that "Investors [and traders] do not want to hold it" – which I still believe is the long term trend. Future markets show this – showing that most investors and traders are still not betting on the Dollar rallying on the back of a "save haven" trade. Furthermore, put options on the Bloomberg Dollar spot index are still net short, showing a bear consensus.
Uncertainty is coming – stay safe, trade safe.
The dollar has seen better days.
In the past 124 trading days, only 46 has been in the green for the dollar index.
Many factors have catalyzed this risk off-trend, and unfortunately, I believe even the key fundamental strength for the dollar has slowly diminished away during this pandemic.
Inflation in the United States diminishes two things. A) The buying power of the U.S. dollar and B) Real bond yields. Both factors disincentivize investors to hold U.S. dollars. Furthermore, with the Federal reserve implementing a new tool specifically to combat low inflation, it all but guarantees that inflation will rise in the near future, diminishing the U.S. Dollar's power.
The Federal Reserve balance sheet stayed relatively unchanged from 2015 to 2020, dipping below 4.5 trillion near the end of 2020. However, due to the increase of asset purchases to stabilize the financial system, their balance sheet swelled up to 7 trillion at the start of August. The buying back of bonds increases the supply of U.S. dollars in the money market, decreasing the value.
Many overseas investors, including myself, are pleased to hear dollar weakness as it entails, I will get more U.S. dollars when I convert my New Zealand dollars to fund my brokerage account. However, if I wanted to sell positions and covert it back into New Zealand dollars, chances are the U.S. dollar's weakness will erase a majority of the gains made. However, with low-interest rates, institutional investors have found it cheaper to short the U.S. dollar to hedge their equity positions from further downwards pressure.
We saw the U.S. dollar rally against other major currency pairs during the peak of the lockdowns in March as major investors sold off their risk-on assets to hold U.S. dollars. However, as the market reaches all-time highs, the U.S. dollar, with its almost guaranteed diminishing yield, has lost interest from investors in favor of Gold.
This is the main problem for the U.S. dollar. One of the only fundamental strengths that the U.S. dollar has had this year was when there was a rush to hold the greenback in the risk-off period we had in the middle of March/April. However, two things have changed since then:
• Market sentiment has favored Gold in Risk-off days
• "Risk-off "periods like March / April is likely not to occur again
Coronavirus cases continue to pile up in India, United States, Australia, and Europe – however, investors have continued to plow money into the equity markets. To put this into perspective, cases in the United States have only worsened since the peak of the recessionary period in March / April. However, the NASDAQ is up nearly 30% year to date. If the market is a voting machine, it has voted that the new normal is the Coronavirus running rampant everywhere, including the United States. Therefore, anything better than that should boost equity markets. And can things can worse in the United States with regards to the Coronavirus?
The dollar is experiencing significant headwinds, both qualitatively and quantitatively. Investors do not want to hold it, future headwinds like inflation are destined to push it lower, and its only strength is slowly diminishing.
Jack McIntyre from Brandywine Global Investment Management stated that "The dollar has been overvalued for a long time, and this might finally be a catalyst for a multi-year downtrend." Furthermore, he said that "As we've seen before when valuations have been stretched, policy or economic shocks can quickly change the currency's trajectory, and that's what it seems to be happening thanks to the Fed's swelling in the balance sheet, a surge in debt, and the way we handled the pandemic."
Liz Young, from BNY Mellon Investment Management, stated that what we're currently seeing in the U.S. dollar ".. is a pullback.." and that "it is a little too extreme to think the dollar is going to lose its reserve status anytime soon."
Bloomberg also stated that investors and traders are currently net short on the currency, with an increase in demand for puts options on the Bloomberg Dollar Spot Index, cementing a sentiment for a bearish trajectory possibly to a level not seen since 2018.
Anish Lal did an excellent technical overview of the trend of de-dollarisation and its effect on other currencies. You can watch it here.