This week’s much-improved US inflation data has had the desired effect on US rate expectations, with the yield on two-year Treasuries climbing again on Friday, as it did on Thursday, to levels above 2.2%. Meanwhile, prices in derivatives markets have adjusted to indicate a 100% probability of the Federal Reserve raising interest rates in March. Ordinarily, such a revision to expectations would fuel a transfer of hot money into US dollars, but dollar traders continue to chart their own course, and that course continues to be down.
By midday in Asia on Friday, the US Dollar Index – a measure of the dollar’s performance against a basket of currencies – had fallen to a level not seen since late 2014, at 88.25.
Also now at 2014 levels is EUR/USD, which breached 1.255 during Tokyo’s afternoon session. For the pair, a significant technical level that might provide resistance in the coming days, should the rally continue, sits just shy of 1.26 (1.2598); that being the 0.618 Fibonacci retracement of the pair’s 2014-2016 decline.
USD/JPY, which this week crashed through major technical support between 107.5 and 108, was down nearly 3% on the week at one stage on Friday, threatening 105.5. When last seen, some mild dollar buying had pushed the pair back above 106, but that offered little consolation to holders of dollars given that rates in and around 106 haven’t been seen since late 2016.
Yen strength appears not to be a matter of reduced risk appetite, with evidence for this coming from the Australian dollar and a number of riskier emerging market currencies. Like other majors, the Aussie has made the most of the US dollar’s current malaise, climbing into the high 0.79s against the greenback on Friday – more than 2% higher than last week’s closing rate of 0.7812 – but investors were also preferring the higher-yielding Australian currency to the relative safety of the euro, yen and Swiss franc.
One explanation for recent interest rates-dollar decoupling came on Thursday from Crédit Agricole’s Manuel Oliveri. In a note to clients the analyst suggested that investors were now playing a long-term game.
“From a longer-term perspective, markets remain uninspired by US economic prospects. Effectively markets continue trading the end of the US economic cycle where any near-term acceleration in inflation may trigger more Fed tightening but will also bring forward the next downturn.”
A further reason for the dollar’s plight was offered by Ilya Gofshteyn, an analyst at Standard Chartered Bank. Speaking to the Wall Street Journal, Gofshteyn said that both the US trade deficit, which in 2017 reached a nine-year high; and the US fiscal deficit, which is expected to increase markedly on the back of President Trump’s tax cuts; were looking “pretty nasty” and were “pulling in the other direction against the dollar.”
The US’ twin deficits made it “more difficult for some investors to stay in the [dollar],” wrote the Wall Street Journal’s Daniel Kruger.
Looking ahead, not much will be changing in the medium-term according to the team at ING. In a report released on Thursday, the Dutch bank had this to say about the dollar’s prospects:
“For the US dollar to re-couple with rising US bond yields…we’d need to see a return in confidence over the medium-term US economic outlook. In effect, this requires a positive reassessment of the extent and duration of this US economic cycle; inflation numbers do not provide this.”
“Broadly, we’re scratching our heads to find any new positive US demand or supply shocks that could change the landscape for an economy in the tenth year of its expansion cycle. Without this, it’s easy to see the weak-dollar story persisting.”
Although early in the year, ING will be happy with what they’ve seen from the dollar so far in 2018. Entering the year, the bank was among the most bearish on the US currency, with year-end forecasts for EUR/USD and GBP/USD of 1.3 and 1.5 respectively – rates that are 15% higher than 2017 averages.
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