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The US dollar made a big comeback, supported by 3% GDP growth and a surprisingly strong ADP report. What does this mean going forward? The team at Dankse answers:

Here is their view, courtesy of eFXnews:

Danske Bank FX Strategy Research argues that the looming decision on the US debt ceiling and Federal Reserve getting ready to pull the trigger on quantitative tightening means that  USD liquidity could start to become scarce from Q4.

“A rebuilding of the US Treasury cash buffer alone would remove about USD350bn from the money market over the last four months of the year. In our view,  this is not currently fully reflected in market pricing of EUR/USD  cross-currency basis (CCS), which could widen further in a situation where USD liquidity tightens significantly,” Danske argues.

To investigate this proposition, Danske’s Short-Term Financial Model (STFM) for EUR/USD  suggests that the isolated impact on EUR/USD spot of a 40bp widening of CCS during Q4 from current levels would amount to  a drop of around three big figures.

“That said, we stress that the development in the EUR/USD CCS is only one of many factors driving EUR/USD spot at present. Notably, we still emphasise upside risks in EUR/USD over the medium to long term from both a ‘flow normalisation’ and a fundamental correction playing out,” Danske adds.

All in, Danske concludes that  the likely USD liquidity scarcity ahead has the potential to, at least, put a temporary lid on EUR/USD in Q4 reiterates its  call that EUR/USD is a buy on dips in the medium to long term.

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