Well, the dollar is sitting near a new YTD high and that’s reignited a number of familiar debates, all which are never far from market participants’ minds.
If stories about the greenback’s “resilience” in 2019 aren’t cooking at full-flame, they’re at least simmering on the backburner. The obsession goes beyond the fact that the dollar is everywhere and always a critical piece of the market narrative.
The Fed’s “epic” dovish pivot “should” have catalyzed dollar weakness. Or at least that was the assumption in some corners.
Really, though, I’m not sure that’s an accurate characterization of anyone’s bearish dollar thesis. “The dollar will slip because the Fed is dovish” is a kind of simplified, stripped-down version of what, in most cases, were more complex/nuanced trade ideas.
Whatever the case, any overtly bearish dollar thesis didn’t play out, for a variety of reasons, not the least of which is that once the Fed pivoted, so did its global counterparts. Fast forward three months from January’s FOMC meeting and everyone (with the exception of the Norges Bank) is dovish. The BoC joined the parade on Wednesday, dropping the tightening bias from the statement and cutting the outlook, while the latest inflation data out of Australia appears to make an RBA cut a foregone conclusion.
Throw in the fact that the BoJ and the ECB were starting from behind anyway when it comes to the normalization effort and you come away realizing that a “patient” Fed isn’t really enough, by itself, to catalyze a sharp pullback (although, as we’ve mentioned previously, the disconnect between real yields and the greenback over the course of the FOMC’s pivot is pretty remarkable – top pane).
US yields have of course bounced this month amid a brighter outlook for the global economy. After falling to the lowest since December 2017 in late March, 10-year yields rose as much as 25bps through mid-April, adding a further impetus for dollar appreciation.
At the same time, the US economy continues to hold up, even as the euro-area sputters (“green shoots” are something of an endangered species across the pond outside of services PMIs) and questions continue to swirl around the durability of the rebound in China’s activity data. The relative strength of the US economy (and “relative” refers to the US versus the rest of the world, not necessarily relative to consensus forecasts for any given data point, because we’ve seen some misses on that score lately), is a boon for the dollar as well.
To be sure, it’s not just a dovish Fed that ostensibly argued for a weaker greenback. Oil prices have exploded higher in 2019 and then there’s America’s increasingly precarious fiscal trajectory which dollar bears habitually point to as a longer-term problem. Between those factors and Donald Trump’s penchant for demanding easy monetary policy, it’s not hard to understand why sentiment in the options market turned decisively bearish last month.
But, as noted a few weeks ago in ““Of Dollar ‘Smiles’, Correlation Breakdowns And Other FX Notables“, getting this call wrong is something that happens a lot. To wit, from that linked post:
It’s funny how the dollar’s behavior always seems easily explainable in hindsight despite the relative dearth of prescient calls beforehand. For instance, looking back on 2018, it’s easy to see how a combination of late-cycle stimulus in the US (and the relative economic outperformance it engendered), a hawkish Fed (as the committee attempted to stay out ahead of a possible economic overheat), dollar+ repatriation effects, favorable yield differentials and a worsening outlook for RoW economies was supportive of the greenback. But if you go back and look at the commentary from January 2018, a lot of what you’ll read found folks focusing on the idea that Trump’s combative trade stance was a weak dollar policy by proxy and that the US fiscal trajectory was deteriorating rapidly. Both of those things are true (especially the latter point), but they were wholly insufficient to overwhelm all the factors that conspired to push the dollar higher starting in mid-April of last year.
2019 is no different in terms of hindsight being 20/20. The dollar’s resilience is pretty easy to explain, if not by way of the rather long-winded reasoning employed above, then simply by reference to obvious headwinds for other currencies.
“It seems to be less about dollar strength and more about currency weakness elsewhere,” Ned Rumpeltin, head of FX strategy at Toronto-Dominion Bank in London told Bloomberg, adding that “the dollar is good enough but we don’t think it offers a particularly compelling bullish case on its own merits.”
Fingers crossed on that, actually. Because as we saw in 2018, a steadily rising dollar is a pernicious thing for fragile EMs and, more generally, for risk-on trades.
For the time being, markets seem content to ignore the contradiction between dollar strength and the euphoria across various risk assets. At some point, though, folks may lose their appetite for strange pairings.