Recent US economic data has started to improve while US dollar positioning among speculators is short, two factors that would normally act to support the greenback.
However, if you’re thinking about positioning for a rally in the US dollar, you’d best wait until the final quarter of the year, says Westpac’s macro strategy team.
Firstly, debt ceiling and government shutdown risk runs high in September and October. The conservative House Freedom caucus once again want spending cuts in exchange for their debt ceiling vote. To avert a technical default Republican leaders need to craft a bill that attracts Democrats. But, in the hyper-partisan climate, Democrats will push for their agenda in exchange for their vote, measures that will result in a loss of Republican votes. All told stalemate is certain and the deadline is tight.
Secondly, the EUR is unlikely to fall materially until the ECB delivers on tapering (i.e. “buy the rumour sell the fact”). The USD during the 2013 taper tantrum is instructive. Bernanke first mentioned tapering in May 2013 and the Fed formally announced the policy Dec 2013. The USD and yields were well supported in that entire period and beyond, into Jan 2014. But, with tapering all but priced in by then, the USD reversed course Jan-May 2014. EUR and bund yields may well behave similarly. Draghi said tapering could be announced in “Autumn”, spotlighting their Oct 26 meeting. If the USD in 2013 is any guide that implies euro remains well supported into that ECB meeting and a meaningful correction is unlikely until it is out of the way.
With those two factors likely to mitigate a recent improvement in US economic data, shown in the chart below that measures the percentage of data beats and misses, Westpac says that any potential rally in the US dollar is likely to be delayed until the final three months of the year.
“Seasonality is much more fortuitous for the USD in Q4 than Q3,” says Westpac, noting that the US dollar has rallied in eight of the past 10 years in the December quarter, a performance in stark contrast to the September quarter where it has fallen in six of the past 10 years.
“The USD is unlikely to mount an effective rally even with the tailwind from firmer data given seasonals and with the ECB yet to make a formal tapering announcement, not to mention Washington gearing up for another showdown over the debt limit.
“Later Q4 looks much more fertile for the USD. By then these key event risks will have been negotiated, seasonals are much more supportive and Washington will begin focusing heavily on tax cut.”