USD - where are all the bulls? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, notes that since its early March high the DXY dollar index has dropped more than 1.5%. More spectacularly the USD has plunged 2% vs. the EUR since March 2.  While short-covering in the EUR is clearly the driving force behind the recent move in EUR/USD, a significant proportion is attributed to a weakening in the tone of the USD.

Key quotes

"At first sight the softness in the USD over the last couple of weeks may appear contrary. After all, speculation of a March Fed rate hikes was building in this period.  This cumulated last night with a 25 bp tightening from the FOMC.  Crucially, however, Fed Chair Yellen did not put aside her dovish credentials.  The Fed’s policy statement recognises that core inflation “was little changed” and “somewhat below 2%” and that “market based measures of inflation compensation remain low”.  This reassurance on the inflation outlook triggered a sharp drop in bond yields which duly sapped the strength of the US dollar. 

The Fed it seems was in no mood yesterday to make any upward amendment to its guidance that it could hike rates 3 times this year. Yellen’s statement that it is “too early” to gauge potential fiscal policy impetus in the US sits well with our view that the market may be disappointed about the about of impetus that makes it through Congress this year.  We still have our doubts about the Fed’s plan to hike rates three times this year.  Added to uncertainty about the size of fiscal stimulus is the concern about protectionist policy stemming from the Trump Administration.  That said, yesterday’s statement from Navarro, the Director of the White House National Trade Centre that the US, Canada and Mexico should form a ‘powerhouse’ signals that the Trump Administration may be prepared to change tact. 

This weekend’s G20 finance minister’s meeting may shine light on how aggressive the Trump administration is likely to follow protectionist goals. The FX market is embroiled in world trade and therefore in any efforts that the US Administration may take to address the US trade deficit.  Whispers that Navarro’s standing may be overshadowed by that of Cohn of the National Economic Council favours speculation that the Administration may moderate its position on trade.  Such talk suggests that sparks are less likely to fly at the G20 meeting.  Also, if substantiated such talk should promote expectations for world growth which in turn should favour risk appetite and the outlook for commodity currencies and those from emerging markets vs. the USD.  

While the robust tone of activity data from the US, China, Japan and Europe has been generally supportive for Emerging Markets this year, the adjustment in expectations regarding the Eurozone economic outlook has also served to promote the EUR vs. the USD.

By the end of last year, the market was heavily positioned long USDs. While this exposed the USD to disappointment, by contrast, the market started the year very short EURs.  The better tone in recent Eurozone economic data, a change in perceptions about the outlook of ECB policy and a reduction in anticipated political risk in the region has also served to strengthen the EUR.

Confirmation that the Dutch electorate has not chosen a populist party to lead their government is likely to calm a few nerves ahead of the French Presidential election this spring. In any case, opinion polls have consistently implied that the far-right’s Le Pen will lose the second round of this election by a large margin.  Confirmation of this is likely to result in further short-covering in the EUR.  Based on the assumption that Le Pen loses the run off, we maintain our forecast of EUR/USD at 1.10 by year end."