Are markets about to buy back into the dollar again? The outlook for the embattled greenback has been a major driver recently, but is it looking stretched this week?
We consider the outlook for forex markets, equity indices and commodities and at what the key drivers of markets are this week.
Dollar weakness has been key for markets in early 2018. Between 2013 and 2016, with the Federal Reserve in the early stages of its tightening cycle, the Dollar Index rallied c. 30%. However in the past year the dollar has weakened considerably. Having peaked around 103 on Dollar Index, last week support at 90 failed and a three year low was reached.
Comments from Steven Mnuchin, US Treasury Secretary drove the move, in which he said that a weaker dollar was good for US trade. However there are other more considerable factors behind the dollar decline. The US dollar remains significantly overvalued, and markets are simply driving the dollar back to more of a fair value against currencies such as the euro, sterling and yen. Also, although Treasury yields are rising as the Fed continues to hike rates, the dollar remains under pressure.
Currencies tend to get most of their strength from the early parts of a tightening cycle and as the cycle matures, the positive affects of rate hikes play out less and less. The Fed is well down the road of tightening, given possibly just a handful of hikes remain, compared to the ECB, BoJ and Bank of England which are just setting out on their journeys.
The US trade deficit is at its worst in 6 years and that China is strengthening the Yuan all add to the dollar weakness. Looking at the Dollar Index, there could be significant further weakness in the coming months, with little real support until 84, at least another 5% decline.
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