US dollar: What a difference a year makes in FX

By:
Farah Khalique
Published on:

The US dollar’s inexorable rally has juddered to a halt this year as it slides versus all but one of the world’s major currencies. Most analysts are sceptical of a strong return and Wednesday’s FOMC minutes only confirmed the US Federal Reserve’s caution.

It is hard to believe barely five months ago Goldman Sachs’ top currency analysts were predicting eurodollar parity – the currency pair is now trading at 1.13 and most analysts have ruled out parity anytime soon.

The minutes of the US Federal Open Market Committee’s (FOMC) latest meeting were published on Wednesday, with nine of the 10 members voting to leave interests rates as they are, citing global economic headwinds.

Therefore, a rate hike in April is unlikely. Markets put a 0% chance of a US rate rise this month and a 54% probability of one by end-year.

RBS_rate_rise-590
Source: RBS


The US Dollar Index, which measures the value of the dollars relative to a basket of foreign currencies, is testing October’s lows and looks "sickly", says Kit Juckes, fixed income and currency strategist at Société Générale CIB.

Furthermore, there are other indicators the dollar is under sustained pressure.

SG_DXY_10yr-330

SG_USD-JPY_SPX-330
Source: Société Générale
"Recent correlations are in a mess," he says. "That doesn’t mean that they are broken – it’s far too early to say that – but the DXY (US Dollar Index)/10yr Note correlation is out of whack today and the correlation between the yen and the S&P (500) or 'risk’ more generally has been under severe pressure for a while."


SG has forecast the US dollar to strengthen versus the euro with a year-end EUR/USD prediction of 1.05, but Juckes says that "feels like a million miles away today".

"[There is] nothing else I like more than the USD at this point in time, but the Yellen Fed is not doing anything to be positive for the USD."

Stalled rally

Indeed, the US dollar has weakened against most major currencies this year, with the exclusion of the British pound, which is under pressure due to the threat of a potential Brexit.

The yen and euro stand out as strong performers, as investors flocked to these safe-haven currencies in light of the stock market sell-off earlier this year.

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Jane Foley, Rabobank
However, despite the return to riskier assets from mid-February through to March, these currencies haven’t really lost any ground, says Jane Foley, senior currency strategist at Rabobank.

"This suggests there is a body of investors who are nervous [that] factors that drove stocks lower at the start of year could come back and haunt us again," she says.

Currency strategists at BNP Paribas believe even a boost in US data is not enough to lift the dollar, due to inflationary pressures coupled with the Fed’s unwillingness to raise rates, according to a research note published on Wednesday.

It states: "A big part of the US dollar’s underperformance against the other core major currencies has to do with the decline in US real yields [the yield on an investment minus inflation], as inflation expectations have rebounded from mid-February lows, but nominal rates remain held back by the Fed’s dovishness.

"Against this backdrop, markets appear reluctant to react even when US data beats expectations."

However, macroeconomics research company Capital Economics is confident that, in light of inflationary pressures building, the Fed will raise rates three times this year, starting from June. This would make the Fed the most hawkish central bank relative to its peers, which ultimately puts the dollar in a stronger position.

"It all depends on what the Fed does with interest rates," says Rabobank’s Foley. "It could hike twice this year. The dollar could recover a moderate amount of ground. The market has already cut a lot of long dollars already, meaning the downside potential has started to run dry."

The good news

US companies are set to announce their first quarter earnings shortly. A weaker dollar is beneficial for US exporters – it cuts the cost of products they sell abroad and boosts revenues when they are translated back into US dollars.

However, analysts are predicting a bloodbath earnings season due to a cocktail of pressures, including currency pressures, and it unlikely this year’s dollar weakness will have an impact quite so soon, says Foley.

"I doubt if a weaker dollar in Q1 will have impacted Q1 results yet – it is unlikely corporates will see that benefit for another quarter or so," she says. "Corporates tend to hedge [in advance], so it takes some months to be more exposed to movements in currency rates."