On Friday, I asked, on behalf of the entire world, whether we’ve seen the last of the “dollar delirium”.
The greenback is coming off its worst week in a decade and, hopefully, we won’t see another sharp move higher anytime soon.
Remember, the world is a friendlier place when the dollar is on the back foot (to quote the affable Kit Juckes). Earlier this month, an acute bout of funding stress (manifested most clearly in widening cross-currency basis) spilled over into the spot market, pushing the greenback “vertical”.
That was “the wrong kind of USD strength” (as one FX strategist put it) and the Fed was forced to step in. Swap lines (which were enhanced as part of the raft of measures rolled out on March 15) were expanded beyond the G-7.
Lingering signs of stress in the yen basis notwithstanding, things have calmed down.
But analysts are divided on whether a second wave of dollar scarcity (and thereby unwanted dollar strength) is in the offing.
“The dollar shortage phase of this crisis now seems complete”, Deutsche Bank’s George Saravelos wrote, in a Friday note, adding that “the next phase will likely be about each country’s ability to exit from the virus lockdowns as well as more traditional macro drivers of FX”.
Those “traditional macro drivers” went completely out the window this month, as the dollar was driven almost entirely by the ebb and flow of funding stress indicators.
For Goldman, on the other hand, the dollar may yet have further to run.
“The dollar pulled back this week as risk assets rebounded, but our best guess is that the historic rally is not quite over”, the bank’s Zach Pandl said Friday.
“In a further equity market drawdown the real trade-weighted dollar has perhaps 3-5% upside from the latest highs”, he went on to suggest, before observing that if the greenback were to summit peaks on par with the last bull market, it could “prompt debate over US-directed intervention”.
Although the Trump administration has been busy tending to other, more “pressing” matters of late, another surge could put the currency issue back onto Trump’s radar screen, especially to the extent any additional upside piles pressure on US manufacturers at a delicate juncture for the domestic economy. “Although intervention has been rare in recent years, the disorderly surge could call for a policy response”, Goldman goes on to say.
(One wonders where the ammunition would come from – the ESF has limited firepower anyway, and now it’s being used to backstop some of the Fed’s new emergency facilities.)
It’s worth noting the similarities and differences between now and 2008. “The scale of the funding crisis in 2008 was of an entirely different dimension for the EUR, in part because subsequent lessons in diversifying funding needs, and averting asset liability mismatches in tenor were heeded”, Deutsche Bank’s Alan Ruskin writes, in a separate note, on the way to reiterating the point above about lingering stress in the yen basis.
“The JPY basis disruption has been of a similar scale to 2008, and proven notably more stubborn to fix than for the EUR swaps market, particularly for longer dated swaps”, he says.
For the bank’s Saravelos, the fundamentals for the dollar “look very poor” both in terms of traditional FX drivers and especially America’s worsening public health crisis – he calls it “virus divergence”.
Fundamentally, he zooms in on the unemployment rate, noting that while the US is prioritizing “protecting the unemployed via higher benefits and direct payments to households” (essentially accepting that mass layoffs are inevitable), Europe is actually bent on ensuring that employment is protected.
When it comes to the virus, the message is simple. “Europe’s exit strategy from the crisis appears more credible”, Saravelos writes, before flatly noting that “virus newsflow will likely improve quicker outside the US”.
On Sunday, Anthony Fauci told CNN that as many as 200,000 Americans could eventually die from the virus, although he cautioned that figure is a “moving target”.