- The US Dollar remains dominant, and each breather looks like a buying opportunity.
- There are three central drivers, and they are set to continue for at least a few more months.
- Things may materially change in the middle of the autumn.
US Dollar strength is a prominent feature for quite a few months. Each time the greenback takes a breather and corrects to the downside, it comes back with a vengeance. Forex trading is never a one-way street, but to paraphrase another cliche, this trend is indeed a friend. Every slip in the buck’s value looks like a buying opportunity.
To sustain a long-term trend and not a short-term counter-trend for profit taking, significant fundamental drivers are needed, and the US Dollar has them.
Strong economy according to the hard data
The US economy is doing well. US GDP grew at an annualized pace of 4.1% in the second quarter, according to the first estimate. This is the best growth rate in four years. Some of it may be related to pre-tariff preparations, but there are other upbeat underlying factors.
Unemployment is low, flirting around the 4% mark. Job growth has been steady many years, averaging close to 200,000 jobs added every month. In more and more sectors, there are reports about labor shortages. This should have led to wage increases, which are still frustrating at 2.7% annualized, it is still better than beforehand.
Inflation is also on the rise. The headline Consumer Price Index is close to 3%, fueled by oil prices. Underlying inflation, Core CPI, is not lagging too far behind, with a 2.3% YoY increase. For quite some time, inflation was too slow, keeping the Federal Reserve up at night. This is no longer the case.
These are all positive, real figures of what has happened and they all support the US Dollar.
Will this last? The economy has enough momentum to keep it going for some time. This may not be as fast as Trump boasts, but indeed a satisfying pace. However, there are early indicators that it will not last Contrary to the past, hard, data; the soft, forward-looking surveys point to a different direction. The ISM Manufacturing and Non-Manufacturing Purchasing Managers’ Indices (PMI) have both dropped sharply in July while still showing growth.
When could we see changes in the hard data? High-frequency indicators tend to have relatively high volatility. The more decisive figure will be the first estimate for Q3 GDP in late October. If the hard data begin pointing to slow growth, this could pull support from the greenback.
The data is published on October 26th.
Trade wars and the elections
The US Dollar is the reserve currency of the world. When things get worse, even if they come from the US, the greenback is a safe haven. The Japanese Yen and the Swiss Franc also play this role, but we have seen how the Yen’s safe status has not been that safe.
Tariffs have hurt confidence, postponed investments, and threaten to do much worse damage to the global economy. But when the US economy sneezes, the rest of the world catches a cold or even pneumonia.
Trump said, “trade wars are easy to win”. Even if the win costs a dear price to the US, the world’s largest economy is still a net importer, while the European Union and China are net exporters. Everybody will suffer, but the US suffers a bit less, thus the US Dollar’s strength.
This Dollar driver may not last that long. Trump is on course to implementing his campaign rhetoric, and for a new campaign: the mid-term elections in November. During his first year in office, trade was not high on the agenda. The recent hardline may be related to the upcoming vote.
Many analysts see him, and his Administration as changing tack after the elections are over. He may make concessions, cut deals that will not change anything and call it a victory. In that case, markets will cheer and move on to assess the damage that was done with a look into the future.
The mid-term elections are held on November 6th.
Hawkish Fed for now
The primary driver of currencies is the behavior of the central bank. The Federal Reserve takes past economic data and future projections (based on trade among many other factors) into account. Yet the stance of the Fed also makes a difference. The current voting composition of the FOMC is more hawkish than in previous years.
Recent comments from Fed Chair Jerome Powell have been upbeat. He said that the economy is doing very well and expressed satisfaction from the improvement in employment and inflation. The Fed’s dot-plot was first upgraded in March to shows more hikes in 2019 and 2020. It was later updated from three to four hikes in 2018. The trend so far has been indicating more rate hikes.
The Fed raised rates twice, in March and in June. Another increase is on the cards for September. It is hard to see the Fed hitting the brakes as recent economic data has been upbeat. However, if GDP becomes worrying in late October, the Fed will have a chance to react when it meets in November. They could signal no hike in December and concerns over trade and the economy.
If the Fed backs down on a fourth rate hike, it will hurt the greenback more than anything else.
The Fed convenes on November 8th.
The US Dollar is well supported by a healthy economy, the safe-haven flows stemming from trade wars, and a hawkish central bank. All this may change in late October and early November with fresh data, the rate decision, and the mid-term elections.
As clouds darken in the northern hemisphere, so could the dollar dive into darkness after an extended period of enjoying the sunshine.