Dollar Scarcity = Dollar Strength Until end-Q1 2018
The US Dollar is tipped to strengthen as the global economy witnesses a shortage of Dollars owing to an increase in US government borrowing.
The US Dollar is expected to gain in value between now and March 2018 as Dollars become more scarce argues Martin Enlund, Chief FX Strategist at Nordea Bank.
Higher-than-anticipated borrowing by the US Treasury will probably 'hoover' up an excess liquidity of Dollars in the financial system between now and then end of Q1, he says.
Within this period Nordea forecast the Pound-to-Dollar exchange rate to fall below 1.30 and the Euro-to-Dollar exchange rate to retrace back towards 1.15.
The call comes after the US Treasury released its forecasts for what it thinks its accounts will look like in 2018 when it estimates its balance will be 300bn - a higher amount than previously forecast.
Although the figure represents a surplus which is arguably unnecessary, the Treasury likes to have a buffer for emergencies - although its size changes depending on circumstances.
Enlund says the higher figure for Q1 2018 will come from more government borrowing, which assumes a speedier resolution to the review of the debt ceiling on December 8, when the Treasury will have to try to get Congress to agree to lift the cap so it can keep a surplus whilst continuing to borrow to fund public services.
"The US Treasury has unveiled a new forecast for its general cash balance. The cash balance is seen at USD 300bn at the end of March of 2018, indicating that it is betting on another quick resolution of the debt ceiling debate (while this is a forecast we stick with this as the best guess in the analysis below)," says Enlund.
Timing
Up until the debt ceiling review, the Treasury is likely to have to reign in borrowing to remain within the ceiling, relying on its cash reserves instead, which will probably result in a fall in the cash balance from today's 198bn to a lower amount.
After the review, however, and given the Treasury's optimism that the cap will be lifted, borrowing will resume apace resulting in the Treasury accumulating a 300bn cash pile by the end of March 2018.
The Dollar scarcity is only likely to be an issue when it gets hoovered up in increasing amounts after December 8, however, Enlund thinks the effects on the exchange rate will be felt before then as the market discounts before the fact.
"This nonetheless translates to a general drop in US excess liquidity by roughly USD220bn between today and the end of March 2018, in comparison to earlier predictions of a modest liquidity boost of USD50bn," he says, taking broad brush approach.
Enlund uses research he has conducted into the correlation between changes in excess Dollar liquidity and the EUR/USD spot rate to argue that changes in the abundance of Dollar have an impact on the exchange rate (chart below).
In light of the research indicating a strong correlation and the new forecasts from the US Treasury, Enlund reaches the conclusion that the scarcity issue will push EUR/USD down to the 1.14 level by December - which represents a downward revision from a previous forecast of 1.15.
And Cable?
As for the Pound-to-Dollar pair, Nordea's October 10 forecasts, said they saw it falling to 1.26 over the next 3 months.
Those are the same forecasts which saw EUR/USD falling to 1.15, but were revised down to 1.14 in light of the Treasury forecast.
Assuming Nordea also revise down their GBP/USD for the same Dollar-scarcity reasons, it would be logical to expect at least a new forecast of 1.25, if not lower.
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The Theme of Dollar Strength into Year-End
The theme of Dollar strength over the duration of the remainder of 2017 is certainly one we have been picking up on here at Pound Sterling Live.
Technical analysts at Goldman Sachs have confirmed their studies see the Dollar index - a measure of overall Dollar strength based on a basket of the largest Dollar-based exchange rates - moving higher.
The move up from the September lows is likely to extend after breaking through a major trendline argues Goldman's Technical Strategist Sheba Jafari, further details of this discussion can be found here.
Economists at JP Morgan meanwhile say their econometric models are now screening the Dollar as a buy for the first time in 2017, further details to be found here.
And Robin Winkler at Deutsche Bank observes the EUR/USD to be obeying signals sent by the yield on long-dated US Treasuries; something he believes should keep the Dollar supported over coming weeks.
