Why is the dollar’s recovery not over yet?

Why is the dollar’s recovery not over yet?

Written by Tom Westbrook

SINGAPORE (Reuters) – A rally that puts the dollar on course for its best year since 1984 should continue further, traders and analysts say, indicating more pain almost everywhere as other currencies collapse or require rapid interest rate increases to stay on. her condition.

The rally – the dollar has risen nearly 15% against a basket of currencies this year – has already been a wrecking ball in foreign exchange markets, crushing the euro and yen to two-decade lows and the pound to near 40-year lows.

Surprisingly hot US inflation data on Tuesday led to the latest rally as investors rose further and faster in US interest rates in response, and they even expect the Federal Reserve could raise a full percentage point next week.

This kind of forecast, and the dollar’s support in the markets, presents a direct challenge to global central banks, which face a choice between watching their local currencies weaken, or slowing the process either by selling dollars or raising interest rates, at the risk of a sharp slowdown. in economic growth.

β€œI don’t think there is anything that can stop the dollar,” said Michael Ivry, a strategist at Rabobank, as long as US interest rates are rising.

“There will be sporadic phases where the market may try to deceive itself and pretend that what is happening is not happening,” he said. “(But) we see the dollar significantly stronger by the end of the year.”

The dollar, which measures the greenback against a basket of six major currencies, was at 109.60 on Wednesday, just below a 20-year high in early September at 110.79. Its year-to-date gains are just shy of the 1984 high of 14.9% for the whole year.

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Gains against individual companies have been massive, with the dollar gaining about 14% on the euro this year, 17% on sterling and about 25% on the yen.

Interest rates have been a major driver, as higher interest rates give dollar bonds and deposits attractive returns.

Outside the United States, the rate trajectories of major economies have looked less aggressive, or stand in stark contrast.

Only last week the European Central Bank turned to talk of ‘forward loading’ increases. China is cutting interest rates, while Japan is holding them firmly at zero. Analysts say the relative safety and strength of the US economy provides additional tailwinds.

“To see the dollar weaken from here, we’ll need to see some of those factors reverse,” said Alex Wolff, head of Asia investment strategy at JPMorgan Private Bank.

β€œWe believe the dollar may continue to see an upward trend in the near term and this strength is likely to continue and we continue to encourage clients to hedge their non-dollar exposure.

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The long rise of the dollar is uncomfortable for trading partners because the increase in dollar import costs comes as the world grapples with hyperinflation.

The biggest disquiet is emerging in Asia as commodity importing countries such as South Korea and India have faced heavy selling pressure on their currencies and economic concerns are making China struggle to contain the yuan’s decline.

But the biggest loser was the Japanese yen. The Bank of Japan’s refusal to budge on a policy of forcing bond yields to stay near zero, while US interest rates rise sharply, has left the yen a natural consequence of the dollar’s strength.

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Bart Wakabayashi, Branch Manager at State Street (NYSE: in Tokyo.

“What’s the impact? Currencies will diverge. Until there is a change in that — either the Fed starts falling or the Bank of Japan starts going up, this has to continue,” he said, with the yen dropping to 147 per dollar. Possibility.

The yen moved away from a 24-year low on Wednesday after reports that the Bank of Japan conducted an interest rate check, clearly preparing for a rare intervention in the currency, although markets believe the respite will not last long.

There is no doubt that the dollar’s rally will surely come to an end eventually and not everyone is betting that there is more to come.

Positioning data shows the market is long in dollars but not significantly so by historical standards, and economists say the goal of higher US interest rates, which is to slow the economy, is ultimately negative for the dollar.

β€œThe Fed has to slow the US economy if it is to bring down inflation. All they have done is remove accommodation. They have not moved into restrictive policy,” said Rob Carnell, head of Asia Pacific research at ING.

But with the timing and nature of the dollar’s eventual decline unclear, most are off track.

β€œWe are seeing big bids on the dollar at the moment,” said Shafali Sachdev, Head of FX, Fixed Income and Commodities for Asia at BNP Paribas (OTC:) Wealth Management in Singapore.

“It remains supportive of the dollar in the short term as the market is in the process of repricing expectations of the Fed’s policy trajectory, expecting a pivot by the Fed on interest rates to come down further.”

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