SOC Gen: The US dollar is about to regain its mojo

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The US dollar, after stumbling recently, is about to resume its move higher.

That’s the view of Societe Generale’s cross asset research team who, in an entertaining note released overnight, believe the US dollar, after overshooting in the second half of last year, is about to resume its uptrend.

Here’s Soc Gen:

“Mr Dollar went too far too fast in Q1 and suffered a significant setback this spring. Call it a mid-life crisis if you will, but it’s not a very serious one. The dollar has recovered only half of the ground lost in the ten years to mid-2011; it has further to go. After a poor start this year, US economic surprises are finally heading north, making it easier for the Fed to raise rates in September. Monetary policy divergence will support further dollar strength”.

Kit Juckes, Soc Gen’s chief market strategist, believes the euro is likely to be one of the major casualties of renewed dollar strength. He suggests the Euro’s “parity party” with the US dollar has merely been postponed rather than cancelled, predicting the EUR/USD exchange rate will slump to 1 in the first quarter of 2016.

Assuming the US Fed begins to lift interest rates in September, and a solution to the Greek debt stalemate found, Juckes predicts that interest rate differentials, specifically the US 2-year swap rate, will once again become influential.

“On a day-to-day basis, the relationship between relative rates and EUR/USD is reasserting itself. The ECB will be on hold in H2 (and far beyond), and the Bund market’s wild gyrations will probably slow. So the driver of EUR/USD is more likely, once again, to be the global risk backdrop to some degree and the trend in US 2-year swap rates to a rather greater degree. These are now flirting with 1% as December 2016 fed funds futures price in a 1.2% rate.

If the Fed does hike rates in September as we expect, and if we get neither a definitive solution to nor a complete collapse of Greek debt talks, the front end of the US rate curve will sell off further and price in additional hikes Looking further ahead, EUR/USD will likely trough when two conditions are met – real rates have risen in the US (and the market has discounted the rate hiking cycle) and the scope for downside rate surprises from the ECB is replaced by a scope for talk of what happens when bond-buying stops.

Both of these are likely to happen in H1 16, suggesting that the trough in EUR/USD, at a rate somewhere below (but closer to) parity, will be seen then too”.

If Juckes is correct this would represent a decline of 11.3% from where the EUR/USD exchange rate is trading today at 1.1274.

Mario Draghi, along with Glenn Stevens and others, will no doubt be hoping that Soc Gen’s dollar call is right.

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