This chart says it all: “Excluding the mega rallies, the latest [US dollar] rally has been bigger than average.”
The thesis this chart is advancing is that the current US dollar rally has gotten too extended and is due for a pullback. The reason it’s due for a pullback is because the rally has been bigger than average. And this is just an average rally.
The chart’s title advances a somewhat specious argument. HSBC note makes a stronger argument.
Here is HSBC rejecting the notion that this time is different:
The current USD bull run has already exceeded this historic average. Since June 2014, the rise has been over 25%. Arguably, one could take the starting point as the low in April 2011, in which case the gain is just shy of 40%. In either case, we have seen a USD rally which is greater than the average seen since the early 1970s. This is already a “big” USD rally.
But some may argue that this should be an outsized rally as USD strength is largely the mirror to unconventional and unprecedented monetary easing elsewhere, and so history cannot be used as a gauge. We disagree. After all, the US has been through the QE process. Chart 2 again shows the DXY index but this time the shaded areas are the three periods of QE in the US. It shows the USD fell roughly 20% during QE1, and another 20% in anticipation of and during QE2. It was largely flat during QE3. So the shifts in the JPY (-35%) and the EUR (-25%) driven by their QE strategies are already greater than witnessed in the US.
The firm additionally argues that the divergence of monetary policy around the globe — tighter in the US, looser just about everywhere else — is already priced in to the dollar and the currency markets more broadly.
HSBC adds: “If monetary policy divergence is so well known by the markets and therefore largely priced in, the hunt should be on for other factors that could determine the next stage in the USD story. We believe a number of these argue against additional USD strength.”
In response, the firm lays out five quick bullets on why the rally is done:
- The cycle is surprisingly EUR-USD bullish
- US tolerance for USD strength has its limits
- Valuations show the USD is ‘rich’
- USD bullishness ahs become all-pervasive
- The USD weakens in the early months of a Fed-hike cycle
On Wednesday following the Fed’s latest policy announcement, the dollar got crushed. On Thursday, the dollar had recovered almost all of its losses.