On the back of lowered expectations for US rate hikes in the year ahead, courtesy of a series of economic downgrades and dovish commentary from the US Federal Reserve at its most recent policy meeting, the US dollar has been struggling to find traction in 2016. Since late January, the dollar index has fallen by over 4%, continuing the broader trend established in late 2015.
While an understandable reaction, given the sway the Fed has when it comes to tilting monetary policy expectations, Westpac’s New York based G10 FX strategist Richard Franulovich believes that recent strength in leading US economic data, along with similar scenarios in the past, points to a likely recovery in the dollar in the period ahead.
Franulovich notes the sharp rebound in recent regional business surveys, lead indicators on how the economy is likely to perform in the months ahead, to bolster his call.
“The handful of regional US business surveys released so far for March – NY Empire, Philly and Richmond – have all posted an aggressive bounce that is almost unprecedented in history,” says Franulovich.
“To recap, the Empire headline index rose from -16.6 to +0.6 in March, the Philly Fed index rose from -2.8 to +12.4 while today’s Richmond Fed index rose from -4 to +22. That puts the Empire survey at 8 month highs, the Philly Fed index at 13 month highs and the Richmond index and near 6 year highs, all but completely reversing the soggy recessionary readings of the last year.
In his opinion, the “the breadth of the stronger March readings – apparent across all these regional surveys – points to a genuine signal rather than statistical noise”.
Pointing to the chart below, Westpac’s US data surprise index, Franulovich suggests that the recent recovery in the index may extend as the data trend continued to improve.
“Our US data surprise index shows a handy recovery to the complexion of the US data has already played out in recent weeks,” he says. “The aforementioned recovery in various regional PMIs suggests further legs to this story, certainly the Chicago and ISM PMIs should be firmer in coming weeks.”
Franulovich believes that the recovery in the data, along with the dovish monetary policy signals offered by the Fed in March, is a similar scenario to that seen last year, something that culminated in the US dollar recovering sharply in the second half of the year.
“In a near carbon copy with recent developments, the FOMC sent a much more dovish than expected signal on monetary policy and the US economy in March 2015. The dovish statement at the time, along with lower growth and inflation projections and a dovish tilt to the dot plot sent the USD sharply lower and helped boost risk appetite and commodity prices deep into Q2 2015Q2,” he notes.
“That occurred even though the complexion of the US data started to firm through much of Q2 2015 according to both our US data pulse and our US data surprise index. By late Q2, amid a much improved trend in payrolls and a stabilisation in commodity prices/inflation expectations, among other things, Fed anxiety waned and expectations for normalisation were back on track.”
Like 2015, Franulovich suggests that anxiety levels among Fed members this year will likely wane, suggesting that the US dollar should eventually start to more forcefully benefit from improving data.
“The USD has struggled to capitalise on the stronger data trends, the dovish Fed signal a key factor,” he says. “But, if developments a year ago are anything to go by, it won’t last long.”
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