Dollar weakness is over
“Dollar weakness is overdone”. That sums up the views of a few sellside currency strategists hitting the inbox over the weekend. But is it right?
(If we knew the answer to that…)
Still, we can take a look at the arguments. The simplest and easiest to interpret is the idea that the recent move lower in the dollar was down to stretched speculative long positioning. The narrative follows that the ‘peak’ inflation print of 7% was taken as the moment to ‘sell the fact’ which has led to a squeeze of dollar longs.
COT positioning data of dollar index futures (chart above via Yardeni), definitely shows a long bias, but there’s not much evidence of a large shakeout there just yet.
Onto the other part of the argument: Most of the ‘good’ news was already in the price. This one’s far simpler to dissect.
- Three rate hikes fully priced in for this year
- 7% annual CPI is a very high bar for inflation data to beat in the next 12 months
- US outperformance gap due to narrow
On that last point, the US "won" 2021 by some distance. For market watchers, it’s the US equity market strength throughout 2021 that caught the eye. The economic strength was notable too however, driven by the huge fiscal boost from the US Government putting money straight into consumers pockets.
As with inflation, it’s hard to imagine the US outperforming by the same magnitude in 2022. So, the general logic is that this year will offer an opportunity for the rest of the world to catch up. Which, in theory, would be expected to see a weaker dollar relative to 2021.
Here’s ING’s take on the recent dollar story:
We think this was mostly due to a sell-the-fact attitude – it is not uncommon this happens around NFP or CPI releases – which triggered a sizeable unwinding of dollar net longs, as well as overseas markets becoming more attractive. We doubt this was due to a real re-rating of the US growth story.
Does there need to be a re-rating of the US growth story?
Markets frequently trade on a relative basis. For example, if US rate hike expectations have topped out at current levels and ECB rate hike expectations continue to rise, that ‘expectations gap’ narrows.
That doesn’t necessarily mean that anything about the US story has changed. All that’s required is for the European story to change while the US story stands still.
Let’s take a look at the price action on the EURUSD chart:
Price broke out above the key resistance in the wake of the US CPI data, and turned lower just ahead of the 1.15 level. Traders will be keenly watching for acceptance if price returns to the breakout zone.
Drilling down to the 4 hour, what happens if/when price returns to the area marked with the blue box will be pivotal.
There’s still a significant long USD speculative position that could be unwound providing a catalyst to push the USD lower (and the EUR higher) If the global growth/catchup story takes hold.
Not investment advice. Past performance does not guarantee or predict future performance.