After months of relentless selling, the US dollar has made something of a recovery in recent weeks.
The US dollar index, heavily influenced by movements in the euro and the Japanese yen, has risen 2.3% from the near two-year low of 91.01 struck earlier this month, benefiting from renewed optimism over the prospect for US tax reforms and further rate hikes from the US Federal Reserve.
After being the whipping boy of currency markets for much of the year, leading to short-positioning among traders rising to multi-year highs, it’s got many wondering whether the tepid bounce seen so far in September can continue in the months ahead.
To Daniel Been, head of FX strategy at ANZ, while the US dollar still appears oversold, he thinks that rather than being the start of a rip-roaring rally, the recent recovery in the greenback will be patchy, particularly against those currencies where monetary policy normalisation is likely to begin in the period ahead.
This chart from ANZ goes someway to explaining why Been thinks the US dollar is unlikely to see broad-based strength.
It looks at current real interest rates for G10 currencies, separating them into highly stimulatory and stimulatory groups.
Real interest rates are nominal overnight interest rates less inflation.
According to Been, much of the strength in the USD last year came from the USD monetary policy transitioning from being highly stimulatory to stimulatory.
However, with the USD now firmly entrenched in the middle of the latter group, he says that “things are more complicated and monetary policy relativities will play a lesser role across all currencies”.
“Against the other currencies in this group, the USD is unlikely to find as much support from monetary policy, as other economies like Australia join the global tightening cycle. This will remain the case unless the US Fed independently creates a new category — currencies with positive real policy rates — and this is not our forecast,” he says.
“As such, confidence that this alone can drive a sustained sell-off in similarly placed currencies (AUD, CAD or NZD) has fallen, while the performance of the USD against currencies in the highly stimulatory bucket will become more contingent on the path of policy of the other central banks.”
So unless the Fed hikes rates so that its real interest rate turns positive, it’s unlikely to see currencies in the stimulatory group fall by any meaningful margin.
And, in terms of those currencies in the highly stimulatory category, Been says that the US dollar’s performance will be dictated by what other central bank’s decide to do.
With US monetary policy taking a backseat in terms of being a major driver of the US dollar’s movements, Been says that investor risk appetite will likely dominate proceedings in the period ahead.
“For the cyclical currencies, the broader environment is likely to have a bigger influence. On this front, most signs remain positive,” he says.
“On the growth front, we are in the midst of a synchronised global upswing. 90% of countries’ manufacturing sectors are expanding, while most of those countries also have export orders that are expanding and inventory levels that are below forward orders.
“This is important because it suggests the trend won’t be short-circuited in the next quarter.”
Cyclical currencies tend to mirror the performance of the global economy, benefiting when conditions are good and weakening when activity levels are on the decline.
Should the current momentum in the global economy be maintained — and he thinks it will — Been says that the USD will “continue to struggle for traction against cyclical currencies”.
He also says that strong and uniform growth should also help to depress volatility levels, another factor that will present a “difficult environment for the USD” against cyclical currencies in his opinion.
“That the broader growth and volatility backdrop still suggests cyclical currencies can perform,” says Been.
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