The dollar rally kicked off in mid-2014, as widely predicted, with EUR/USD falling 22% from 1.37 a year ago to around 1.07 today. The strong rally came as no surprise to the Street, but market consensus that the dollar run is far from over has come as a surprise to some.
All eyes are on tomorrow's US non-farm payrolls – a rise in employment figures will no doubt boost the dollar – but some analysts believe the market is wilfully ignoring persistent disappointing data out of the US.
|US dollar: special focus|
Daragh Maher, FX strategist at HSBC, says: "Numbers out of the US are softer than expected, while numbers out of Europe are better, which the market has largely ignored. Under normal circumstances, this would be a reason to stop selling EUR/USD."
The market appears to be heavily focused on the underlying divergence in monetary policy between the US and Europe – the European Central Bank has embarked on quantitative easing to boost the economy, while the US Federal Reserve is expected to hike interest rates as its economy strengthens.
However, this argument is starting to look stale, according to a recent report published by HSBC titled USD Bull Run: The Beginning of the End.
Monetary policy divergence explains much of the dollar rally seen so far, but it is already priced in now.
Another popular argument for betting on a rising dollar is that US interest rates will rise a lot more than markets expect, but HSBC remains cautious, stating: "Our view on this line of thinking is: if you think you know what is going to happen in the interest-rate markets, why are you trading the USD? Just trade the interest-rates market instead."
The underlying data draw a picture that is at odds with the market's assumption of a strong US recovery. HSBC's Surprise Index measures economic activity in the US and the eurozone.
For much of 2014, the US Activity Surprise Index was on an upward trajectory, but since late last year it has plunged as shortfalls in US data have started to mount. Conversely, the Eurozone Activity Surprise Index has soared upwards since late 2014 as economic data going into 2015 have signalled a revival.
However, the market seems content to ignore the fundamentals, according to analysts at Morgan Stanley in a report published on Wednesday.
"There appears to be a greater tendency to look through the current soft patch, maintaining focus on the sustainability of the broader USD trend," it states.
'Enjoy the party, but dance close to the exit' – this Japanese saying could easily apply to the US dollar bull run, which is arguably closer to the end than the beginning.
The dollar has rallied more than 25% against the euro since June, and almost 40% since its low in April 2011. This is already greater than the average dollar rally since the early 1970s, which is about 20%. Only two other rallies stand out – the first in the early 80s when it nearly doubled in value and the second in the mid-90s when it rose by almost 50%.
Camilla Sutton, chief FX strategist at Scotiabank, believes the US dollar will continue to strengthen, but at a more moderate pace than in the first quarter of this year. Scotiabank predicts EUR/USD to slip to 1.10 by the end of this quarter.
"We are starting to get surprises and some downside movement in Q1, now there is a more balanced view," she says.
Meanwhile, four previous Fed tightening cycles over the past 30 years show the dollar has fallen in the period immediately after the first rate rise, and after additional rate increases. The boost to the dollar from Fed tightening might well already be priced in, so by the time the Fed raises rates the dollar might repeat history and take a tumble.
"There is too much greed and not enough fear at play, and it begs the question of why the market is accepting a viewpoint with such unanimous agreement," says HSBC.