Wall Street has an expiration date for the dollar’s epic rally

Rate this post

Americans who want to take advantage of the historic strength of the green dollar with a vacation abroad should consider booking sooner rather than later. After an impressive rise over the past year, the dollar period in multi-decade highs may have finally come to an end.

That is, if a handful of Wall Street strategists are to be believed.

One of them, UBS, told customers on Wednesday that “the best days of the dollar may be behind us.”

At the end of April, the US dollar reached its strongest level against the euro since the end of 2002, reaching a high of 1.05 euros per EURUSD dollar.
very close to the “parity” or the level at which a euro would be worth a dollar. Since then, the green dollar has softened a bit. However, a popular indicator of the strength of the green dollar against its main rivals, the US dollar index ICE, has gained more than 13% DXY,
+ 0.75%
over the last year and more than 6% so far.

These are massive movements for foreign exchange markets, where daily movements are usually measured in basis points or fractions of a percentage point.

The strength of the greenback over the past year has been attributed to a number of factors, including:

Changing interest rate expectations: The Federal Reserve has released what markets expect to be the fastest rate of rise in benchmark interest rates since 1994. Meanwhile, the Bank of Japan maintains the easing of its monetary policy, while the European Central Bank he has recently stated his intention to start climbing. its benchmark rate later this summer for the first time in 11 years.

Record inflation: Higher inflation in four decades has helped stimulate the Fed to act more aggressively, while raising nominal yields (although it weighs on real yields).

Safe shelter flow: Although inflation has weakened the dollar’s purchasing power at the national level, concerns about the slowdown in economic growth in Europe and China (which could see its GDP growth rate during the year fall to for the first time since the mid-1970s) have precipitated foreign purchases. of the greenback in what market experts have described as a “flight to safety”.

But in recent weeks, investment strategists at investment banks in Europe and the United States have increasingly considered that the recovery of the dollar has followed its course.

UBS, the Swiss megabank, has officially estimated that the dollar has reached a secular turning point and will return some of its gains in the coming months as the Fed raises rates.

UBS is not the only investment bank to adopt this view: according to the average estimates of 44 brokers, Wall Street sees the euro-dollar pair strengthen in late 2022. The average estimate is that the euro is trading at $ 1.10 at the end of the year. compared to Wednesday’s $ 1.07.

A similar pattern holds for the dollar-yen pair, which has an average year-end estimate of 125 yen per dollar, compared to nearly 130 yen per dollar on Wednesday. The average figure between the dollar and the yen is based on estimates from 31 brokers.

Presenting its bearish argument for the dollar, UBS analysts noted that the Fed’s favorite inflation indicator, the personal consumption expenditure index, rose just 0.2% month-on-month. April, marking the smallest increase since November 2020. followed by a month-on-month increase of 0.9% in March.

This indication that inflationary pressures could be waning (at least in the US) has spurred an improvement in long-term equilibrium rates, a measure of market expectations for the future. For example, the U.S. 10-year equilibrium rate has dropped to 2.6% this week, up from 3% a month ago, a sign that investors’ confidence in inflation-fighting capabilities of the Fed is improving, according to UBS strategists.

In turn, this has caused expectations of the Fed’s rate hike to moderate: the futures of Fed funds, an interest rate derivative used by traders to hedge or bet on the movements of the Fed. Fed benchmark rate target, currently priced at 266 basis points. of rate hikes for 2022, compared to about 285 basis points in a forecast released in early May.

The UBS team added that the scope of the dollar’s gains over the past year has been staggering: “Although we have targeted the USD short-term since the beginning of the year With the tightening of the Fed, the magnitude of the appreciation has exceeded our expectations, “wrote the team, led by Mark Haefele, UBS’s director of global wealth management investments.

They now see the risks to the greenback as being “more balanced”.

Given that the dollar plays a special role in the world economy due to its status as a reserve currency (which we have explored in more detail here), the strength of the dollar over the last year has created problems, especially for governments and corporations of developing economies, which often finance at least part of their debt in dollars and euros.

Last month, a team of Bank of America currency strategists explored the possibility that continued dollar strength could lead Hong Kong to abandon the Hong Kong dollar’s peg to the green dollar. Hong Kong is not the only economy that ties its currency to the dollar (many Middle Eastern countries do too, including Saudi Arabia). Breaking these bindings could lead to more market disruption.

More recently, Steve Barrow of Standard Bank discussed the still purely theoretical case of central bank intervention to weaken the dollar.

“We certainly don’t see any case right now, because the US is pushing for a much-needed tightening of global financial conditions. But there is a danger that this could go too far and fall too much into the currencies of emerging markets,” Barrow wrote. the head of G-10 strategy, in a note to Standard Bank customers.

Finally, there is the historical pattern. Over the past four cycles of rate hikes, the dollar has weakened normally over the 12 months following the Fed’s first rate hike. He exhibited this pattern in the years 1994-1995, 1999-2000 and 2004-2005. The only exception was the short hiking cycle that began in late 2015, which saw the green dollar strengthen over the following year.

Surely, there is also the possibility that more shelter flows and continued continued differential yields (as U.S. rates are rising faster than those in Europe and Japan) will help keep the dollar high.

After all, just because a certain asset or currency has historically been traded with a certain pattern does not mean that that pattern is destined to be repeated.

Source link

Leave a Comment