• Joel

USD Testing June Highs... Where Next?

USD just about made fresh three week highs this morning, with DXY eclipsing June 22nd’s 97.74 highs for a brief moment before pulling slightly.

DXY is thus trading at levels near levels not seen since right at the start of the month, an impressive bounce from sub-96.00 lows clocked on June 10th.

So where next for USD?

First, it is worth reminding ourselves as to why USD got slammed so hard at the end of May/beginning of June.

1) Risk on flows

Risk assets made impressive gains in the month of May and the early part of June, with market’s focused on a cocktail of better than expected global economic data (which raised hopes for a V-shaped recovery) and continued reopening of developed economies. These strong risk on flows weighed on USD.

2) Improvement in EUR sentiment

Eurozone risk premia (i.e. the risk of a Eurozone break-up) diminished markedly in the latter half of May/beginning of June. EU Leader’s finally began making progress towards an agreement on the EU Recovery Fund, which included agreement on the idea of jointly issued EU debt. This was seen as drastically reducing the probability of Eurozone break up, thus EUR rallied hard, which was of course bad for USD (remember, FX markets are all about relativity, so when one currency strengthens, all others must weaken against it. Other asset classes do not necessarily work like this).

3) Fed dovishness

The Fed continues to out print virtually all other major central banks combined (as referenced by the rate of its balance sheet expansion), meaning that growth in USD money supply is far outpacing that of other central banks, meaning it started to seem almost inevitable that USD would weaken.

How have these three factors changed?

1) Risk appetite has stumbled, and stocks are fair amount off recent highs. The primary culprit for the market’s presently much more defensive positioning is the spike in Covid-19 cases in the US, as well as continued growth in cases globally. Increased trade tensions between the US and EU and China have not helped.

2) Momentum towards an agreement on the EU Recovery Fund appears to have waned somewhat (it was initially hoped a deal would be done by the end of June, now it looks more likely to come at the end of Summer.

3) The Fed is still just as dovish in its actions as ever, although Chairman Powell yesterday was a little more upbeat on the outlook for the US economy than some had expected given rapidly growing Covid-19 second wave risks.

Other factors to consider…

Other notable factors that influence USD price action to consider include the fact that US President Trump, typically seen as a USD positive President, has slid dramatically in the polls, with most election calculations now predicting (based on current polling) a clean sweep for Biden in the November election.

So where next for USD?

Should risk appetite continue to fade due to Covid-19 concerns as well as heightened trade tensions, this seems likely to be a USD positive, if it manages to hold onto its safe haven status. Moreover, markets seem to have priced in the fact that Trump is probably not going to win re-election, so continued bad performance by him is unlikely to further weigh on USD sentiment. In this scenario, DXY could regain a fair amount of the ground it lost over the course of May in the month of July.

There are a few threats this view, however. Firstly, the outbreak is worse in the US than Europe, and so the US economy is likely to underperform the European economy, which might end up actually being a USD negative as it would be a positive for EURUSD.

Moreover, the Fed continues to pump and has not ruled out more stimulus should the economy need it (such as if there was a double-dip recession due to the Covid-19 second wave in some states).  

All the while, what if EU leaders surprise markets by finalising the EU Recovery Fund deal faster than expected? This could give EUR a big boost at the expense of USD. 



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