USD: Soggy summer? – Rabobank

In view of Jane Foley, Senior FX Strategist at Rabobank, the soggy performance of the USD since the start of this year has in part been a function in the coincident improvement in Eurozone fundamentals. 

Key Quotes

“The better tone in Eurozone economic data became noticeable in forward-looking PMI data right at the start of the year and followed through into other readings.  This was followed by a reduction in perceived political risk in the Eurozone, most notably after the French election.  The increased attraction of Eurozone assets through into the spring coincided with a reduction in optimism with respect to the outlook of the US economy.  The resultant rotation out of the USD and back into EUR assets has lifted EUR/USD around 6.5% since the start of the year.  While the EUR has been the best performing G10 currency this year, the USD has been worst performer.”

“Since the Federal Reserve is the only G10 central bank to have hiked interest rates this year, the poor performance of the USD is on first sight surprising.  However, this year’s poor performance for the USD vs, the EUR must be set against the expectations that were built into the currency pair at the end of last year.”

“The election of Trump into the White House caused a wave of optimism over reflation that has subsequently being reversed.  By the end of last month the DXY dollar index had returned to level last traded just ahead of last year’s US election.  CFTC speculators’ USD net long positions have also been trending lower this year from their December highs.  However, long positions remain far higher than their levels at the middle of last year.  This may be appropriate given that the FOMC is widely expected to announce a third 25 bp rate hike since December 2016.  However, in our view the rotation from USDs into the EUR still has further to go.”

“We expect that the Fed will announce another interest rate hike at today’s policy meeting and possibly even repeat its mantra suggesting another move is likely by the end of the year.  None of this should surprise the market.  However, we do not expect the Fed to be able to follow through with another rate hike in 2017.  In recent weeks the market’s confidence in a third 2017 rate hike has been diminishing.”

“In order to prevent a repeat of Bernanke’s ‘taper tantrums’ it is assumed that the Fed will communicate its intention regarding the balance sheet well before a programme is initiated.  This implies a message could be communicated at today’s FOMC.  Theoretically any reduction in USD liquidity should be USD positive and is a threat to our expectation that EUR/USD can climb towards the 1.15 area by year end.  However, we would expect the Fed to approach balance sheet reduction with caution.”

“The ECB will also be similarly concerned about the lack of inflation in the system.  May CPI inflation dropped back to 1.4% y/y in May from 1.9% y/y in April vindicating the dovish rhetoric of ECB President Draghi.  For this reason we see no ECB rate hike this year, although we do expect tapering of QE during 2018.  In reflection of our expectation that the ECB will refrain from moving quickly in the coming months we expect a consolidative tone to dominate EUR/USD on a 1 to 3 month view.”