Dollar Index Closes In On Multi-month Lows As Fed Minutes Loom

- USD nearing Feb lows & risking further losses
- As European economies reopen & EU FX rallies
- Fed minutes in focus after dovish FOMC speak

Dollar outlook

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The Dollar Index was eyeing multi-month lows Tuesday while risking a more protracted breakdown as Europe took its first steps in the reopening process and risk currencies outperformed, although investors’ responses to Wednesday’s Federal Reserve meeting minutes will be key to how the U.S. unit ends the week.

Dollars were sold en masse ahead of the mid-week session after while European currencies were bought heavily, placing the Dollar Index on course for a fourth consecutive session of declines, with price action playing out amid tepid declines in global bond yields and gains for risk assets like stocks and commodities.

The Pound-to-Dollar exchange rate accounts for just less than 12% of the ICE Dollar Index and came within inches of its February highs on Tuesday, which would also be Sterling's strongest level since 2018.

UK job data came in stronger than expected for March when the unemployment rate posted a surprise fall, with the figures released as the UK further relaxed restrictions on supposedly non-essential business activities.

“The break above the 1.22 in EURUSD is technically significant, but even more so because of the underlying dynamic in European debt markets and relative EUR interest rates,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Most notably for the Dollar Index however, EUR/USD rose to its highest level since February having broken above 1.22 and opened the door for an extension toward January highs around 1.2349, which is a bearish development for the ICE benchmark of the U.S. currency.


Above: Dollar Index shown at daily intervals with 10-year U.S. yield and EUR/USD.

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The ICE Dollar Index is 57% composed of the Euro-Dollar rate so is especially sensitive to movements in a European single currency that was a strong performer ahead of the mid-week mark as major continental economies including France and the UK took steps to reopen from ‘lockdown’.

“A thicket of support in the 89-90 zone will make downside progress more of a grind than smooth sailing,” says Richard Franulovich, head of FX strategy at Westpac, referring to the ICE Dollar index.

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Dollar losses and Euro gains looked to be aided on Tuesday by Eurozone bond yields that have risen amid a reopening-induced improvement in sentiment, which also comes amid discussion in some parts of the analyst community about a possible June adjustment by the European Central Bank (ECB) to the pace at which it buys continental government bonds as part of its pandemic-inspired quantitative easing programme (PEPP).

Net purchases carried out under the programme have declined in recent weeks, potentially enabling the turn higher in German and other government bond yields which some observers say are supportive of the single currency and a prospective ongoing burden for the U.S. Dollar.


Above: 10-year GB bond yield alongside equivalent U.S. and German yields.

“A key challenge and test of the rally would be any fresh strong rise in longer US treasury yields, which were a major USD support back in March,” warns Steen Jakobsen, chief investment officer at Saxo Bank, referring to Tuesday’s stock and commodity market rally.

The Dollar rallied last week when inflation surprised sharply on the upside of economists’ expectations by rising to an annualised 4.2% for April and more than twice the Fed’s target level, aided by a resulting surge in U.S. bond yields, in price action which arrested a prior sell-off induced by an April non-farm payrolls report that surprised on the downside of market expectations.

Exchange rates have been highly sensitive to key economic figures coming out of the major economies of late, with the Dollar itself being quick to deflate last Friday when April retail sales figures missed lofty economist expectations.

“Vice Chair Clarida said “we have not made substantial further progress" on the Fed's goals for employment and inflation (a necessary requirement for tapering), and he (again) added “we will certainly give advanced warning before scaling back those purchases”. Clarida continued to downplay the spike in the April CPI report by saying upward pressures on inflation are likely to be "transitory" due to mismatches between supply and demand as the economy reopens,” says Kevin Cummins, chief U.S. economist at Natwest Markets.


Above: Dollar Index shown at weekly intervals with Pound-to-Dollar exchange rate.

Losses built this week as various Federal Open Market Committee (FOMC) policymakers reiterated the Federal Reserve’s view that America’s job market is a long way from the “substantial further progress” in returning to full employment that is necessary for the bank to entertain changes to its policy settings.

The Federal Reserve is also seeking to use its monetary policies to generate even more inflation than it has ever sought in the past such that inflation averages 2% over an unspecified period of time, rather than merely reaching 2%, before the bank lifts interest rates.

This is expected to take an extended period of time during which at least some other major economy central banks would likely have an opportunity to wind down crisis era quantitative easing programmes or even begin lifting their own interest rates first, which is a bearish backdrop for the greenback.

Nonetheless, the Dollar and wider currency market will likely scrutinise minutes of the Fed’s April meeting closely when they’re released at 19:00 London time on Wednesday night for signs of unease with or dissent over the FOMC’s policy position.

“USD is down across the board. The FOMC ultra‑dovish guidance will further weigh on USD but the latest US Treasury International Capital (TIC) data is an early warning indication that the bearish USD case may be less compelling,” says Elias Haddad, a strategist at Commonwealth Bank of Australia.

“Net foreign purchases of US long‑term securities surged to near an eight‑year high of US$552bn in the 12‑month to March driven by a sizeable reduction in net foreign selling of Treasuries. Over the same period, the US trade deficit totalled US$765bn. The implication is underlying demand for USD is improving as the widening US trade deficit is partly offset by rising net foreign purchases of US long‑term securities,” adds Haddad.

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