After a stellar run in recent years, the US dollar has been in the wars of late. Weighed down by a slower-than-expected rate tightening schedule from the US Federal Reserve, improved sentiment towards the Chinese economy and a modest recovery in global economic data, has been detrimental to the buck, seeing the US dollar index slide close to 4% year to date.
Though not a complete surprise given the scale of its appreciation over recent years, the question many in markets are now grappling with is whether the recent slide is a temporary blip or the start of a longer lasting trend.
Some think it is, others not, predicting a resurgence in the dollar in the latter parts of the year.
To Daniel Been and Brian Martin, FX strategist at the ANZ, while the recent weakness may persist for a while yet, it’s far too early to declare the dollar’s rally over.
“On a medium-term (12 month) basis, we believe that it is far too early to declare the end of the USD rally,” say Been and Martin.
“Indeed, beyond the next quarter, we continue to think that the ultimate path for the USD against USD/Asia currencies and against the commodity crosses is higher due to a number of structural trends remaining in play. Ultimately, these factors will overwhelm the cyclical improvement that we are currently experiencing.”
The pair suggests that central banks in general will play a smaller role in determining currency direction, suggesting that decisions from the Federal Reserve will remain central as to how markets will behave.
“We doubt the Fed can remain as dovish as they have in recent communications for long,” they note, mirroring similar sentiment to that expressed by Westpac strategist Richard Franulovich in a research note released last week.
“Our analysis shows that employment has been the most significant contributor to core inflation. It also suggests that there isn’t a lot of room for a weak USD to add to inflation without the rate rising well above the Fed’s forecast. This should limit the duration of the Fed’s dovishness.”
The chart below, supplied by ANZ, puts what Been and Martin are talking about into visual form. Even with the drag on core inflation from the weaker US dollar, price pressures continue to edge higher of on the back of tightening labour market conditions.
“Should all of these trends extend as we move into the second half of this year, the Fed may find itself in a position where it looks like it has been too conservative, and as such, long-term nominal bond yields will rise to better account for the growth improvements.”
“This would likely generate volatility and again means that the ability for the USD to be at the start of a longer term sell-off is limited.”
The table below, also from ANZ, reveals the banks forecasts for the US dollar against the majors along with a swathe of Asian currencies. With the exception of the British pound, the bank is expecting US dollar strength to resurface in the second half of 2016.
Commodity currencies, in particular, are forecast to be hit hard, reversing the strength seen over the past six weeks. By the end of 2016 ANZ sees the AUD/USD trading at 67 cents, nearly 10 cents below its present trading level. Beyond that, the bank suggests the Aussie will bottom out at 66 cents by the middle of next year.
“Commodity markets will continue to be plagued with excess supply. While this does not guarantee there is further downside, it certainly limits upside (in iron ore and oil in particular), and will keep a lid on commodity currencies and on the ability for their related economies to begin to outperform,” says ANZ.
The view presented by ANZ differs vastly to that offered by strategists at the CBA who have the AUD/USD trading at 80 cents by middle of next year.