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An unfolding battle for the Dollar


19 May 2021

The markets are now seeing renewed pressure on the US currency and an increase in demand for risky assets due to soft comments from the Fed. Richard Clarida reminded us that the FOMC would warn us before considering winding down its asset purchase programme for the central bank balance sheet. Rafael Bostic pointed out that “it is not the time” to think about policy changes. Both agree that the labour market is unstable, and therefore, the pressure on prices is temporary.

These comments cemented the market reaction to the labour market report earlier in the month when the Dollar fell and stock buying intensified. Later markets tensed up, fearing the Fed’s reaction to accelerating inflation. However, the Fed continues to react asymmetrically to the information, wary of any weak data and slow to celebrate robust statistics.

All this created a negative backdrop for the US currency and allowed the Dollar index to plummet under 90: a significant round-level support during the last five months. EURUSD and GBPUSD also took their round levels, with the Dollar crossing 1.2200 and 1.4200, respectively.

It is now as if history from the early 2000s is repeating itself, the days of the “Greenspan put” when the Fed maintained a stimulative monetary policy, finding a weakness in individual economic indicators and ignoring the overall acceleration in the economy and inflation. With this policy, we have seen increased pressure on the Dollar against major competitors and multiple increases in the prices of underlying commodity assets.

Long-term investors need to understand that the situation may be radically different from what we saw 20 years ago. After all, a lot is in the hands of politicians, including the lessons of the past. Yet, at the same time, the market’s reflexive reaction so far is repeating all this, forcing market participants to sell dollars and to bet on emerging markets and commodity assets.

We will have to listen carefully to the words of the Fed members once again when the dollar index is renewing multi-year lows. Note, the dollar index is now at 89.75. This year’s low is 89.16, and 2018’s low is 88.15. This concentration of pivot points promises an interesting battle in the currency market in the near term. However, so far, we see more signals in support of bearish USD positions.

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