Why does the dollar have a crown? US exceptionalism, which is now under threat, plays a major role. As soon as more data that undermines the US reputation flows into the markets, the dollar will begin to deflate. When will this happen and will it happen at all?
The growth of the dollar seems to have stalled. The US currency plunged by 3% in a little more than a week after strengthening by 10% in three months. This happened at a time when the markets began to receive unfavorable statistics and the specter of a recession appeared. Doubts are growing in the investor environment about whether the American economy will be stable as before, and monetary policy will be tough, as previously expected.
Other factors
It is unlikely that the specter of a recession has become the only problem for the dollar's growth. This is one of the factors that occurred at the time of the confluence of other circumstances. There are opinions that the depreciation may be due to the demand for protective assets. The Russian-Ukrainian conflict, which suppresses the appetite for risk, has waned.
The US is still ahead of other major countries in the process of monetary policy normalization. However, recently there have been more and more statements and real signals for a rate hike in Switzerland and the eurozone.
European Central Bank President Christine Lagarde admitted that it was time to act. At the beginning of the week, in her speech, she hinted at the imminent end of the bloc's life with negative interest rates. The eight-year ultra-soft policy may end by September. Of course, this supported the euro, putting pressure on the positions of the dollar index, where the European currency occupies most of the share.
Money markets still expect an increase in interest rates in the US by about 175 bps by the end of the year, but now there are nuances. They, among other things, began to predict an increase in ECB rates by about 100 bps against 20 bps.
The US rate hike cycle is embedded in the quotes, if they see the prospect of a more aggressive tightening of policy, the dollar will begin to decline. The fact is that investors will resume carry trades.
The dollar has problems
Given the high risks of recession, there is little faith in the possibility of the Federal Reserve raising the rate by more than 50 bps in the future. On the contrary, intriguing information began to appear.
Fed representative Rafael Bostic allowed a pause in raising rates. In September, the central bank may suspend this process in order to make some assessment and summarize how successful this scheme is in the fight against inflation. But here you need to read between the lines: the main purpose of the pause is to prevent a recession and check how the economy worked during the period of severe rate hikes. The markets are not worried in vain, the specter of a recession is real.
Even JPMorgan, which is optimistic about the dollar, hints at the existing difficulties with further growth of the exchange rate. According to economists, the markets are concerned about the US exclusivity under attack. The global economic slowdown will certainly affect the United States.
At the end of last week, market players reacted to the weak macroeconomic reports for a reason. Data ranging from unemployment to housing and business conditions indicate a slowdown in growth in the United States.
Traders will begin to study the Fed's minutes, the dollar may have a chance to rebound and continue the rally. This will happen only if the FOMC minutes reflects the desire of the central bank's team to take tougher measures to combat inflation.
The argument in favor of strengthening the hawkish tone will cheer up the markets, which will start laying for a 75 bps rate increase after the next two meetings, where a decision on rates has already been practically announced (a 50 bps increase).
The fact that some hawks will offer to actively sell mortgage-backed securities to cool the booming housing market may be perceived as a tough attitude. This would mean more active withdrawal of money from the markets.
Otherwise, the dollar index risks repeating the test of the 101.65 area in the near future. Next, dollar bears will have a prospect of visiting the 100.90 mark.
The rules of dollar growth
If you look more closely and study the movement of the US currency, you will notice that it almost always strengthens before the central bank rate hike, and then begins to roll back. So, in three of the last four cycles of increase, the dollar index on average plunged by 1.4% between the first and last rate hike. This analysis was conducted by Reuters. It is not a fact that history will repeat itself, but there is some common sense here.
There are serious doubts in the markets about the further appreciation of the dollar. Some demonstrate confidence in passing the peak of the growth of the US currency on May 13.
ING is betting that the Fed will still pause after raising rates to 2% in July. At the same time, there are also economists in the markets who continue to believe in excessive rate hikes in the US and the strengthening of the dollar.
The fact that the dollar could have passed the peak of growth is a rather serious statement and not everyone agrees with such unsubstantiated and hasty conclusions. We need to gather more information, including on the situation in the euro bloc.
With a high probability of a recession in Europe and a drop in the confidence of global investors, the dollar will "repair" its reputation by quickly resuming growth.
