The USD bull market - in place since 2011 - is complete.
This is the view of analysts at TD Securities who have assessed the state of global monetary policy following the ECB's Forum on Central Banking in Portugal in late June and found the landscape has shifted to favour non-Dollar currencies.
TD Securities have warned this outcome was to play out in the first half of 2017, and they believe their call has been justified by the decision of central bankers from the UK, Europe and Canada to point to suggest they were looking at a higher interest rate future.
They are already catching up with the Fed, which is not the only bank anymore to be raising - or contemplating raising interest rates.
“Several major central banks have taken clear steps toward a new hawkish reality and the USD has weakened sharply as a result. We have been waiting for exactly this rotation to arrive, however, and it has underpinned our expectation to see the USD’s uptrend to come to an end in H1,” says Richard Kelly at TD Securities.
The USD will not only lose ground but will end a long-term structural trend higher which has been unfolding since 2011.
Monetary policy “divergence” between G10 currencies and the Dollar has now given way to “convergence”.
Global growth appears to be trending higher and supporting the more confident outlook for the rest of the world, and “the market’s new focus on G10 central bank hawkishness beyond the Fed is the natural, and expected, consequence,” says Kelly.
Near-Term Stability on Technicals
But, it would be wrong to expect a headlong dive for the Dollar from here as the outlook is nuanced.
The call for Dollar weakness is a medium-term call, however, and despite the bearish stance TD expect some Dollar strength in the short-term, due to Dollar over-selling.
“With the USD looking oversold from several perspectives, we think investors have become too bearish too quickly. We think the USD’s macro backdrop is likely to improve somewhat over the next few weeks, hinting at risks of a short squeeze ahead,” said Kelly.
In the near-term, Kelly sees EUR/USD range-bound between 1.11 and 1.16.
The recovery will prove temporary, however, and the Dollar will start to weaken in the medium-term.
When the Dollar starts to wane, the Euro will take over and provide “leadership” whilst the Pound will be hampered by Brexit uncertainty.
Other currencies will follow an idiosyncratic but bullishly biased track against USD.
CAD, for example, has already risen versus the Dollar due to hawkish rhetoric from its central bank, and such has been the surprise it rose despite a 10% synchronous decline in oil, to which it is highly correlated due to Canada’s primary export being crude.
Another weight on the Dollar the Fed’s new higher rate path already having been priced in.
“At the same time, investors have clearly acclimated to the new era of Fed rate hikes, in our view. With four rounds of tightening now under their belt, we think it is very telling that the USD TWI is actually lower than it was when the FOMC delivered their first hike in
December 2015. More to the point, we think it is particularly interesting that the TWI actually finished lower the day of the last two Fed moves, 15 March and 14 June,” said TD’s Richard Kelly.
Outlook for EUR/USD
In their analysis of Dollar medium-term weakness, TD focus predominantly on the impact of the phenomenon of policy convergence on EUR/USD.
EUR/USD’s advance is complete for this part of its move:
“EURUSD has already backed away somewhat from its end-June highs at 1.1445. This has come despite a few data readings that otherwise should be supportive of further gains. While we are careful not to read too much into market behaviour during what is normally a very quiet week of summer holidays. This does, however, increase our confidence that the EUR’s advance is probably close to complete for this part of its move,” said TD.
From a technical perspective, the pair stopped at a major trendline connecting the August 2015 (1.1714) and May 2016 (1.1616) highs.
A break above the 1.1616 highs, however, would signal a breakout above this trendline and support a continuation higher, plus the start of a new more bullish trend.
Ahead of this and in the short-term, however, TD expect the Dollar to bounce back from oversold levels, and EUR/USD consequently to fall.
“The first area of significant support should arise around 1.1295, but 1.1110 and 1.1023 should provide a firm backstop against any reversal lower,” said TD.
A move below 1.0820 would lead TD to question their medium-term bullish assumption and change their strategy.
The dip in the near-term will provide Dollar bulls with excellent buying opportunities.
There will then follow the medium-term, rally.
“There, if upward momentum in EURUSD continues to build, we certainly acknowledge the possibility that our longstanding end-2018 forecast of 1.23 is realised more quickly than we currently expect. We would expect similar effects to be seen in other G10 currencies, allowing for the natural variation created by each economy’s specific drivers,” concluded TD Securities.