The US dollar rally has stalled in recent days, including on Monday, as investors began to question whether Donald Trump will be able to deliver higher US growth, inflation and interest rates.
The US dollar index (DXY), having rallied over 8% from the lows struck during the US presidential election, has now fallen by 3.7% from January 3, closing below the 100 level for the first time since November 11 overnight.
To Daniel Been, head of FX research at ANZ Bank, even with the recent pullback in the dollar index, it is “starting to look expensive” based on ANZ’s fair value model.
“Our model of the DXY suggests that at present the dollar is overvalued by around one standard deviation,” says Been.
“While this doesn’t mean that a significant reversal is imminent, it does suggest that in the near term, further gains are becoming less likely and the risk/reward has now tilted to having a short bias.”
ANZ’s fair value model is found below.
Been suggests that this short bias — indicating that US dollar weakness is more likely than strength in the period ahead — will persist until the model, and currencies become “better aligned”, noting that the pattern seen in 2016 may yet again prevail in 2017.
“In the second quarter of 2016 this happened as the DXY fell, while fundamentals improved, and in 2017 we expect a similar script to be followed,” he says.
Given the view that the US dollar may continue to weaken in the period ahead, Been says that upside risks to commodity currencies, including the Australian and New Zealand dollars, exist in the short-term.
That view fits with the view presented by Been two weeks ago when he provided four reasons why the Australian dollar was likely to return to the previous range high of 78 US cents in the period ahead.
Been says that while he retains a bearish bias for the USD for now, he will track risk sentiment closely as it “remains the key near term risk to his bias.”
“The key to a revival of USD strength will either be significant underperformance in US rates markets, or a sharp deterioration in sentiment,” he says. “Neither of these are on our radars this quarter”.
Beyond the short-term, Been says that the 2017 USD uptrend is unlikely to be as “powerful” as it was in 2013-2015, suggesting that the “new normal” for the US dollar is for slower appreciation with more frequent retracements.