Is The Greenback Really Back? Yes and No
We explain why the US Dollar likely underperforms in H1 but outperforms in H2
The US dollar is performing well so far this week. It’s up circa 1% on the week, having posted strong daily gains, particularly on Monday and Tuesday. Importantly, it has also broken out of the downtrend that has been in play since the start of November.
Despite this move, we’re sceptical of a strong move higher over the coming month or so, but are USD bulls for the second half of this year. Sound confusing? Stay with us.
Why the Dollar has popped higher this week
The main driver has been the continuation of US yields moving back higher, as investors scale back expectations of steep interest rate cuts.
This follows better-than-expected data over the past week, with CPI inflation coming in at 3.4% vs 3.2% expected and Initial Jobless Claims lower at 187k vs 205k surveyed.
US yields have jumped, with the 1yr now at 4.83%, the 5yr back above 4% and the 10yr at 4.10%.
Add into the mix comments the Fed’s Christopher Waller, who commented (in regards to rates), “I see no reason to move as quickly or cut as rapidly as in the past.”
Watch for yourself to get a feel for his thoughts on the matter. Fast forward to 23 minutes to get to the key part.
This has naturally fed through to a stronger dollar.
Why we are out-of-consensus short-term USD bears
Despite being longer-term USD bulls, we see the pop this week as a good opportunity to start scaling into short positions.
To understand why, we want to talk about the USD smile. This economic theory states that we see dollar gains when either the US is outperforming the rest of the world (i.e., let the good times roll) or when it’s being bought as a safe haven asset (during times of trouble). In the middle of the smile is the situation when the dollar weakens, where the rest of the world outperforms the US. This is shown below.
Of note, we see dollar gains in the best-case and worst-case scenarios. However, we feel that the coming months will reflect more of a move to the middle part of the curve, which would signify USD weakness.
Inflation is dropping in many developed lands. Earlier this week at Davos, ECB President Lagarde hinted strongly about summer rate cuts but cautioned the markets about getting too optimistic.
Here in the UK, despite the latest inflation reading being higher than expected, other data points to a resilient economy. For example, the latest Services PMI reading of 53.4 was the highest since last June.
In the short-term, we feel the outperformance of the RoW relative to the US, or certainly, the desire to take on riskier non-USD trades, is there. That’s the key factor that supports our view of a weaker USD.
See our trade ideas section below for USD plays.
If you are not already, consider becoming a premium reader to access full articles and trade positions, along with our Monday weekly rundown.
USD Bulls Into H2
Into the second half of the year, we see the picture changing. While the odds of a US recession are still finely balanced, it looks more credible to see other nations head into one first.
For example, the EU posted a Q3 GDP contraction of 0.1%. It’s touch and go as to whether Q4 was any better, but we feel that it’s only a matter of time before data starts to roll over and investors start to get worried again.