Here’s why USD might be in for a near term rally
Having been slammed over the last 8 or so weeks, USD appears to have entered a period of consolidation. Having managed to bounce from support at the 92.50 mark three times over the past seven trading session, DXY is trading more comfortably around the 93.50 mark.
Having come such a long way over such a short period of time (indeed, DXY begun July around 97.50 and ended it around 92.50 for its worst monthly performance in over a decade), there are increasing arguments for USD make some near term gains. Lets examine these…
1) Rising US/China tensions
Last Friday, markets got a reminder that US/China relations are still VERY sour and continue to only get worse. The US put sanctions on Hong Kong Leader Carrie Lam in another big escalation of diplomatic hostilities (remember only about a week before this the US surprisingly closed down a Chinese consulate in Houston, Texas). USD got a solid boost off of this news; US/China tensions have typically been a USD positive story over the past few years.
China responded today with sanctions on high level US officials, as you would expect – they typically respond to any US measures with proportionate measures of their own.
Clearly the US is the aggressor here, and there is no telling over how much they will choose to escalate tensions ahead of the election – US President Trump will likely use this as a means of increasing his eroding support base.
The US is already putting pressure on Chinese companies over data collection/espionage, over the South China Sea, over Hong Kong, over the Uighars, buddying up more closely with Taiwan (a big enemy of China) and on many more issues. Should tensions continue to escalate this month, USD could see further upside.
2) Rising US economic optimism
Last Friday, another factor boosting USD was better than expected US jobs data for July. Fears that, net-net, jobs would have been lost in the month due to rising Covid-19 cases proved unfounded, despite a number of states having to halt/reverse reopening plans.
There is growing evidence then that the US economy is performing somewhat better than expected at the moment; US economic weakness compared to its peers (such as the UK, Eurozone and Canada etc.) had been a key argument used in July to sell dollars.
Perhaps the US economy is underperforming its peers by less than we might have initially imagined, meaning USD might be deservedly in for some upside.
US retail sales data released this week, perhaps the second most important monthly data release after NFP, could add more weight to the argument that the US economy didn’t perform as badly in July as feared. This data will be closely scrutinised on Thursday and if there is a decent beat on expectations, USD could see some decent upside.
3) USD short positioning is increasingly extreme
Signals that USD is being oversold (and EUR overbought) are growing. The latest positioning data (released on Friday) had the highest proportion of speculators short USD in 8 years. Moreover, nearly a record percentage of speculators were long EUR.
Profit-taking has already been given some of the credit for DXY’s rally from last week’s lows. But should this “profit-taking” continue, we could have something more akin to a short-squeeze – this is where a solid proportion of the market who are short (which is most of the market) panic at the rising price and get out, causing the rally to strengthen.
Further USD profit taking or even a short-squeeze could bring USD back higher in the next few weeks.
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