Over the past week or so, the USD has been showing a little more resilience against the persistent selling, which in fairness seems to have little behind it as intra day traders push the greenback around in established ranges. Once we hit the extremes, it is a different story, and the DXY is back testing 0.9000 again with a view to challenging stronger levels from 90.40, with the sub 0.8900 move last Monday proving short lived.
DXY Weekly Chart
While the FOMC rate hike last month was priced in, the overreaction to the lack of a material movement in the dot plot from 3 to 4 rate hikes this year was reversed pretty quickly, and also highlighted the short term opportunism in the market at present. That said, the median dots have actually moved higher, but at this stage and with the data at hand, the market consensus remains at 3 for this year, which in itself should see some adjustment higher in the USD given median forecasts were for 2 hikes in the very early part of this year.
We have however, seen correlations with rate differentials breaking down with currencies, but this could improve if next week's data out of the US can help longer end rates retain better levels in the face of the steepening rate path which should see the Fed Funds rate at 2.0% (at least) but the end of the year.
At this point it is also worth noting the USD/JPY move away from the sub 105.00 lows seen last week, with the benchmark 10yr Note relinquishing support at the 2.80% mark. Technically, 3.0% was a strong obstacle, but with recent volatility returning to the equity markets, fixed income was set to benefit to some degree, so this is more to do with the risk relationship between the JPY and stocks, with the cross rates also holding up to a larger degree.
USDJPY Daily Chart
Consequently, we are looking for greater re-evaluation of the EUR and GBP against the USD in coming weeks, where we see the overstretch clearly having run its course, as we highlighted in our EUR outlook last week. Some are pointing to widening USD funding spreads (LIBOR/OIS) as a source of recent USD strength, but this relationship has been anything but consistent when looking at 3m USD LIBOR vs OIS over bot the the short and longer term horizon, and we put much of this year's USD weakness down to the heavy selling of US Treasuries out of Japan - to the tune of $22.5bln over Dec-Jan according to recent TICS data.
EURUSD Daily Chart
USD strength(ening) should also see some impact on the commodity markets, but at the present time, and due more to the US-China trade spat, is only having noticeable influence on industrial metals to the chagrin of the AUD. Here we have seen better performance in the USD over recent weeks, so its seems the weightings in the USD index are more reflective of more recent weakness - a departure from the overstated view that EUR gains are significantly down to a lack of confidence in the USD.
Off the back of a (seemingly) revolving door at the White House, impulsive policy decisions and limited restraint in public spending, which naturally exacerbates the view/perception on the budget deficit, any material appreciation in the USD seems hard to envisage, and to that end, the best we can expect is a staggered recovery or as we continue to see more as a correction.
Even so, with a little more relative (or comparative) sense of perspective, the domestic data argues for further adjustment against the EUR, CHF, while we can also see gains vs the SEK and NZD, but less so the AUD (as already alluded to) and the CAD.
Once markets return to full strength after the Easter break, we will have received the March ISM manufacturing PMI data, with the non-manufacturing index due midweek - both serving as a taster to the main event at the end of the week which is the March payrolls report. Earnings growth is expected to fluctuate inside the 0.1-0.3% range, but if we see the unemployment rate slipping towards 4.0%, if not a little lower, it should ease the conscience of the Fed to keep the normalisation path on track, if not a touch steeper. Irrespective of this, our (long awaited) view is that whether we get 3 or 4 rate hikes, the USD valuations look out of kilter based on current econometrics (relatively speaking). Sentiment can outstretch these differentials for so long, and it now looks as though the greenback has a little more fight in its belly.
by Shant Movsesian and Rajan Dhall MSTA
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