The market has been very unenthusiastic about the dollar in recent months, with traders anticipating that the currency’s decline in 2017 and in the opening weeks of 2018 would be sustained throughout this year, writes Oliver Mangan.
However, the dollar turned very stable over the spring. More recently, rising US yields have unnerved dollar traders, who have started to unwind some of their short positions. This has seen the dollar rising between 2.5% and 4% against a broad range of currencies over the past two weeks.
The extreme market positioning suggests there is a further unwinding of dollar short positions to come, especially in the context of 10-year US Treasury yields rising to 3%, a firming of market expectations in regard to Fed rate hikes, and signs of a loss of momentum in economies outside the US.
For now, then, with growth outside of the US underwhelming of late, it would seem that the dollar has regained the upper hand.
This is impacting interest rate expectations. Markets have pushed back the date of the next hike in UK rates to August from May and also scaled back the amount of policy tightening they expect from the Bank of England.
Meanwhile, the ECB is taking a very cautious approach regarding any monetary tightening. Rates in the eurozone are not expected to start rising until the second half of next year, with much speculation also that the ECB could extend the timeframe for asset purchases under its QE programme beyond September.
Recent currency moves, though, are unlikely to signal that last year’s dollar decline is over. There are real concerns about the current policy mix in the US, with
fiscal policy being expanded at this late stage in the cycle when the unemployment rate is down near 4% and interest rates remain very low.
The rise in the US budget and balance of payments deficits from the expansionary policies are a long-term negative for the currency. Meanwhile, US growth will eventually slow on monetary tightening and as the fiscal stimulus fades.
The slowdown in growth outside the US also seems to be partly due to temporary factors such as the weather. Thus, the pace of activity could well strengthen again in Europe from the second quarter onwards, helping the euro and sterling. The momentum is behind the US currency, with more dollar traders likely getting squeezed out of their short positions.
Oliver Mangan is chief economist at AIB
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