Forex Friday: Dollar halts 6-week winning streak
Fawad Razaqzada May 20, 2022 8:16 AM
In this week’s edition, we discuss why the month of May hasn’t gone to plan for dollar bulls
Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there. In this week’s edition, we discuss the dollar and its less than impressive performance so far this month.
Why has the dollar been going up?
For the past several months, investors have been piling into the dollar because of two reasons, which go hand-in-hand. First, a stronger US economic performance compared to the likes of the UK, Eurozone, China and Japan. Secondly, interest rate differentials between the US and the rest of the world made the dollar the top choice for investors. Given the strength in inflation and speeches by several Fed officials of late, it looks like we will get a few more 50 basis point rate hikes in June, July and September, before switching back to the standard 25bp hikes thereafter. It is likely that the Fed will pause hiking by early 2023, or even sooner should the economy turn sharply lower.
What has changed?
Well, not much wouldn’t be a totally wrong answer, but the markets have now had several months of hearing the same thing. The key question is whether the Fed’s front-loading of interest rate hikes is now priced in fully. The dollar’s reversal this week certainly suggests investors are at least entertaining the idea of it. Some might even be wondering whether the central bank will have to cut rates again in 2023 or beyond to lift the economy out of a possible recession.
Unavoidable recession looming?
As we saw with several retailers this week, price pressures are squeezing company margins and consumers’ pockets. Some fear a recession is unavoidable and the Fed won’t be able to do anything about it because its hands are tied. It will have to deliver on its mandate which is price stability and full employment. The latter is basically achieved, but the former, well, need I say more?
Additionally, it is worth remembering that the strength of the dollar is going to hurt US exports and company profits made abroad in foreign currencies when repatriated back into USD. So, that’s something else investors will be taking into account when discounting future performance of the dollar. On a more micro level, the dollar is undoubtedly weighing on company earnings made abroad, as when those sales are converted back to the USD, they won’t look as impressive.
So, perhaps, we are closer to a dollar top against certain currencies than the interest rate differential between the Fed’s monetary policy and that of the rest of the world might suggest. Eventually, the Fed might be forced to make a U-turn in monetary policy and that’s what markets are focusing on right now. As a result, we have seen bonds halting their recent sell-off, causing a small dip in yields and the dollar.
Euro, franc and yen among currencies showing signs of life
Meanwhile, some downbeat foreign currencies are in demand. The euro for example has shown signs of life amid growing hawkish rhetoric among ECB officials. The Japanese yen and Swiss franc have found some much-needed love amid haven demand after the big sell-off on Wall Street in mid-week. If these trends continue, then surely it will exert more, if limited, pressure on the dollar index in the weeks ahead.
Dollar Index in retreat
The dollar index is set to close lower and end its 6-week winning run. If stays below 103.21, it would also remain in the red for the month of May, potentially providing a topping signal since the breakout above the high of 2017 at 103.82 earlier this month didn’t hold. The index is also back below the high of 2020 at just below 103.00. Thus, for as long as it holds below 103.00 now, the short-term technical outlook would be bearish.
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