Here's why USD can't catch a bid at the moment
Towards the end of September, things were looking good for the USD bulls. Between the 21st and 25th, the dollar index (or DXY) rallied some 200 points to 94.75, its highest levels since July.
Traders, investors talked of the beginning of a long-overdue USD short squeeze. Indeed, over the past few months, USD short positioning reached its highest levels in eight years (and EUR longs to near record high long positioning), and over the five day rally noted above, there was a noticeable reduction in short USD positioning (although the market remains very short USD).
Rarely is the market positioned so short USD heading into an election, or so the logic goes; thus many expected the USD upside to continue into early October.
But the opposite has happened. USD demand has petered out and DXY has slipped to the mid-93.00s (currently trades close to 93.50). Certainly not a huge sell off, but still, far from what the bulls were looking for.
Here’s why demand for USD has subsided…
1) Since the 25th of September (USD’s most recent peak), global equity markets have been on a solid run to the upside. The S&P 500 has recovered from September lows around 3200 to trade around the 3400 today (around a 6% recovery).
As we know, “risk on” driven gains in global equity markets are typically a negative for safe haven USD; my analysis shows that DXY has a negative correlation to the S&P 500 of just under -0.2… as in a 1% move higher in stocks is generally associated with a 0.2% move lower in USD. So with stocks 6% up from September lows, you can all do the maths!
As to the reason why stocks have been rallying, the main positive theme has been 1) an unexpected revival in US fiscal stimulus talks between the Democrats and Republicans and 2) generally stronger than forecast global economic data.
2) Since last week’s Presidential Debate between US President Trump and Democrat Nominee Biden, Biden has expanded his already large lead in national polling over Trump, with the same trend also being seen in a number of key swing states such as Wisconsin and Pennsylvania.
Markets are thus increasingly pricing in the probability of a Biden Presidency that markets are for now seeing as a USD negative, given Biden’s softer trade and foreign policy is expected to be better for global growth prospects, which reduces demand for USD relative to EM and other currencies.
3) USD no longer seems to be the market’s preferred safe haven currency. Despite the general recovery in risk appetite over the past week and a half, we have been through a few bouts of risk off (not least when Trump contracted Covid-19). In recent months, USD would have been the outperformer under such circumstances, but over the last week or two, this has not been the case. Rather, markets have opted to buy JPY in times of risk off – many now expect JPY to remain the favoured safe haven currency ahead of the US election (of which the uncertainty created, by definition, undermines the general appeal for USD).
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