The euro is making progress in an upward trajectory as the United States dollar is losing value across the board.
The United States dollar is standing to lose more value in the upcoming short term as a variety of factors are down pressing the currency.
1) Resurgence of a risk appetite – Risk appetite tends to be negative for the United States dollar. Risk appetite can be noted as: a rise of the U.S. treasury yields, a rally in equities, appreciation of commodities (oil), and a broad rally in beta currencies, while safe haven currencies lose value. Beta currencies include: the euro, the British pound, the commodity dollars (Australian, New Zealand, and Canadian). Safe haven currencies include: the Swiss franc, the Japanese yen, and the United States dollar. A drop in implied volatility of EUR/USD suggests carry trade is slowly inching into the market place. A continuous drop will play negative for the USD.
2) Bernanke Boost – Bernanke’s comments in Jackson Hole have boosted optimism around the globe. The market participants took Bernanke’s comments that additional round of stimulus to encourage economic and labour growth might originate as soon as September. Additional stimulus is clearly dollar negative on a longer term perspectives. Inputting more stimuli into the United States economy will lower the value of the currency, a policy which has been clear by the government for some time. Comments from the Fed suggesting that the interest rates will not be raised until mid-201, further suggests a long term downtrend for the dollar emerging.
3) 10-year differential to come back – A positive correlation between yield differentials of German and the United States 10-year yields is likely to come back. Whenever, the differential drops, the EUR/USD tends to follow suit. The correlation broke down in early August, but as history shows the correlation should come back to the table. In turn, appreciation of German yields which should happen as contagion in the Euro-zone is slowly becoming capped could lead to greater yield differentials. If yield differential between Germany and the United States rises, so will the value of the EUR/USD currency pair. Also a drop in peripheral CDS, in particular those of Spain and Italy, is helping out EUR/USD optimism rally.
4) The United States dollar funding appeal – With a resurgence of risk appetite, the market place will look for places to borrow cheaply. Since the United States (as well as Japan and Switzerland) possess relatively low interest rates, the market is likely to borrow in dollars and lend it elsewhere. Subsequently, a carry trade will likely to make a presence as long as global optimism continues to hold. A carry trade will deem negative for the United States dollar on longer term perspectives, as market participants borrow in dollar and sell the dollar to grasp benefits of higher yielding assets in other nations.
5) IMM positioning suggests traders are loading on shorting the USD – Slowly but surely, the market participants are beginning to interpret an abundant amount of weakness in the United States dollar down the road. Market participants, widened their short positions of the United States dollar by $2.5 billion to net short position of $18.6 billion. The trend is likely to remain intact as abundant amount of money continue to sit on the side lines. We continue to hold that the EUR/USD can make a run towards a 1.47 threshold by an end of the year, if status quo persists.