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Why Strategists Are Bullish on the Buck

Garry Gay | Photographer's Choice | Getty Images

Central bankers in Japan, Britain, and the euro zone were facing high investor expectations when they had their meetings this week — and it appears they have delivered.

The Bank of Japan is embarking on a monetary easing campaign more aggressive than anything it has attempted in years, while the European Central Bank has reopened the door to further easing later in the year. Even the relative lack of action by the Bank of England is giving the market fodder for trades.

Currency experts reading the tea leaves from the central bank news are focusing on different elements, but for most of them, one theme is emerging loud and clear: with the outlook for the U.S. economy improving while weakness remains in other G4 countries, central bankers in Britain, Japan, and the euro zone are if anything committed to more aggressive easing, which means the dollar is poised to dominate in the near term.

"You're into a major currency war now. Japan has just laid down the gauntlet," said Paul Richards, head of global FX at UBS. At the same time, while the U.S. has a way to go to achieve full economic recovery, "there are very good signs you're seeing strength coming into the economy."

Ian Stannard, head of European FX strategy at Morgan Stanley, also expects the dollar to move significantly higher against the yen. Even apart from the Bank of Japan's aggressive easing plans, Stannard points out that the dollar has lately been strengthening on positive economic news — breaking a longtime pattern — and that is making it more expensive for Japanese investors to hedge their dollar exposure. If they reduce their hedging activity, "that will be another boost for dollar-yen."

He thinks the firm's year-end target of 105 yen to the dollar is "very much achievable."

There were fewer surprise headlines emerging from the European Central Bank meeting, but President Mario Draghi's comments after the interest rate announcement — comments thought to indicate Draghi was more negative on the economic outlook for zuro zone countries — left investors expecting more weakness in the euro relative to the dollar.

"Let's not forget that while the European Central Bank and the Federal Reserve are both currently engaged in aggressive monetary easing, the ECB is debating over the need to increase stimulus whereas the Fed is debating over tapering asset purchases, " wrote Kathy Lien, a managing director at BK Asset Management, in a note to clients.

Steven Englander, global head of G10 FX strategity at Citigroup, also expects a stronger dollar relative to the euro. While the euro rose slightly after the central bank meeting, "European bank stocks are down, peripheral yields are up, German yields are down – I suspect this EUR rally is temporary," he said. "The news is that the ECB is likely to cut next month, but there is little expectation that will be successful in stimulating growth – hence, it is negative for EUR," and thus a plus for the dollar.

You might think that the Bank of England's decision to stand pat on further easing would hurt the dollar, but Morgan Stanley's Stannard disagrees.

The pound, he said, "is actually likely to come under some further pressure. We're likely to continue to see some further weak data coming through but with inflation continuing to push higher, that I think is going to leave the BOE still with a tricky position." Overall, he expects the pound to move down to the low 1.40s against the dollar in the coming months.

There are doubters. Jens Nordvig, global head of FX strategy at Nomura Securities, expects the Australian dollar to outperform the U.S. dollar relative to the yen because recent economic reports from the U.S. have been relatively disappointing and the Australian dollar "remains a key focus of both institutions and retail investors in Japan."

For the most part, though, FX strategists — who tend not to agree on much — for now are bullish on the buck.

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