23 March, 2015
The dollar may have had one of its sharpest sell-offs in years on Friday, but we continue to think that the buck is king in the FX world, and the shake out on Friday was more positioning rather than a change in trend.
As we start a new week EURUSD has given back some of Friday’s gains, but it is managing to hold on above 1.08 as we wait for a key meeting between Germany and Greece to discuss how to avoid a Greek default as early as next month.
So why did the Dollar fall so sharply on Friday?
The dollar had been moving in the same direction as stocks for some time, however, that relationship broke down last week. As global stocks rallied, and stock market volatility fell, the dollar turned lower. Thus, the dollar may struggle when stocks rally in the coming days.
The ultimate factor that weighed on the buck was the Fed. The market noticed hesitancy in the FOMC statement last Wednesday to commit to hiking rates, which led to a bout of dollar profit taking.
CFTC positioning data: short EUR positions turned lower again last week. When positioning is this extreme there is a risk that the market will take profit.
These are potent reasons why the dollar was the weakest performer in the G10 last week, falling sharply vs. the Kiwi, the Aussie, the Swiss franc and the EUR. However, at the start of a fresh week it has been able to pull back some recent losses against the GBP, CAD and franc, suggesting that the dollar sell off is not broad-based.
However, we think that dollar bulls need to show some discretion this week, as the dollar’s performance may not be consistent across the G10. Two pairs we will look at closely include:
1, EURUSD: This pair could be due a longer pullback/ period of consolidation after such a hefty fall in recent weeks. The biggest risk is the meeting between Germany and Greece on Monday. However, even if the meeting breaks down in disarray, this doesn’t mean that the EUR will fall off a cliff. The EUR actually rose during the last period of Greek-induced volatility during the general elections in January. Thus, we are wary of looking for the EUR to falter this week, especially as the market seems happy to take profit.
2, GBPUSD: this pair is much more at risk. Firstly, the pound is the weakest performer in the G10 vs. the USD so far on Monday. It has not been able to sustain Friday’s gains, suggesting that bearish GBP sentiment still has the upper hand. Last week’s weak UK wage data is causing the market to question whether the BOE will actually raise interest rates this year. One of the reasons why GBP is stalling on Monday is because it has lost some of its yield effect. The spread between UK and US 10-year bond yields is close to its lowest level since 2006.
Also worth noting if you are trading GBPUSD is 3-month volatility in this pair. Vol has spiked to its highest level since 2011, which is not surprising, with less than 2 months to go until the next general election. Political uncertainty is likely to continue to build in the coming weeks as the election campaign gets into over-drive. If that happens then we may continue to see GBP falter.
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