Dollar Surges Against Pound and Euro

Finally, some volatility has hit global foreign exchange markets and the U.S. Dollar is rising in notable fashion

The Pound to Dollar exchange rate is quoted three-quarters of a per cent lower on a daily basis at 1.2628 at the time of writing Tuesday, and the Euro to Dollar exchange rate is down 0.60% at 1.0880.

A look at the G10 performance board reveals the Dollar is up against all its peers, confirming a distinct USD outperformance is underway:

Above: USD relative performance on January 16, image: Pound Sterling Live.

A look at the global stock market landscape reveals the reason behind the Dollar's advance is the sharp move lower in global equity markets, from Asia, through Europe and to the U.S. pre-market futures.

This tells us we are witnessing a deterioration in investor sentiment that favours the safe-haven status of the Dollar.

Raffi Boyadjian, Lead Investment Analyst at XM.com, says dovish expectations for the major central banks - a central pillar of the late-2024 weakness in the USD and strength in equities - suffered a setback on Tuesday after ECB Governing Council member Robert Holzmann cast doubt on the prospect of any rate cuts in 2024.

Speaking at the World Economic Forum in Davos, Holzmann cited the heightened geopolitical risks in the Middle East as posing a significant threat to inflation," says Boyadjian.

Holzmann sounded downbeat on the likelihood of the disruptions to shipping in the Red Sea ending quickly, prompting him to warn that “We should not bank on the rate cut at all in 2024”.

"Markets normally get off to a flying start in January – but this year markets are dominated by a series of disruptive events," says John Meyer, analyst at brokers SP Angel.

Meyer's list of events that are holding back seniment is as follows:

1. The Fed is threatening to hold back expected interest rate cuts. This seems to be holding a strong US dollar and while dampening US-dollar denominated commodity prices.
2. US election issues are creating some uncertainty though, Trump changed much less than his strong rhetoric would suggest.
3. China continues to bail out property developers and local municipalities through a variety of schemes.
4. The collapse of shadow banking giant Zhongzhi Enterprise Group into bankruptcy which oversaw >$140bn of assets at its peak and now has around $39bn of debt is a major issue.
5. The BoJ is expected to start to tighten its ultra-loose monetary policy, but when will this happen?
6. The war in Ukraine dominates the agenda, with Europe continuing to suffer the impact of higher energy prices and lower business and consumer confidence.
7. Many automakers are slowing or halting factories on supply chain disruption from Asia caused by Houthi missiles into the Red Sea. Container shipping is rerouting round South Africa adding an extra 10-16 days to the journey and around an extra $2m per journey. This means that ships are losing around 20-30 days per round trip due to the effective closure of the Res Sea / Suez.

To be sure, sentiment has held up pretty well, despite the long list of market worries, with the S&P 500, a benchmark for global investor sentiment, rising for nine of the past 11 weeks.

Yet, much of that uptick in sentiment occured in the latter parts of 2023 and was driven by increased confidence that the Federal Reserve will cut interest rates in the coming months, which can boost U.S. and global growth.

As 2024 dawns, those rate-cut bets are receding, and investors are looking at the risks and questioning their exposure.

Above: The inverse relationship between the S&P 500 and the Dollar index (lower panel).

"The soft-landing narrative has captured the minds of investors. The expectations of more disinflation and meaningful central bank rate cuts, as the global economy dodges a recession, explain the rally in both the S&P500 and the EURO STOXX 50 since late October," explains Mathieu Savary, Chief European Investment Strategist for BCA Research.

Savary says the market is due for a correction, and his research suggests "many things must go right for sentiment to increase further."

"Do not chase European equities higher from current levels. The rally has already absorbed highly optimistic expectations regarding growth and inflation in 2024," says Savary in a new report.

The prospect of U.S. Dollar outperformance in a shaky sentiment backdrop is high.