Dollar Makes Comeback, Helped by Rising Rates
The dollar is standing a little taller, for now.
It’s not so much about the change in price, but the change in attitude towards the greenback.
The dollar index was lower on Friday and is about a half percent lower year-to-date. But for the month of March, the dollar index has gained 1.3 percent and the dollar is 1.1 percent higher against the euro.
Strategists say the dollar is poised to strengthen further, and some say it could continue to do so at least until mid-year.
“I think it’s healthy…in that we don’t have a big panic in the market and still the dollar gains. It’s sort of an old-fashioned move, where we have better U.S. data, higher interest rates, and the dollar responds to it,” said Jens Nordvig, head of G-10 currency strategy at Nomura.
The dollar weakened Friday after a disappointing consumer sentiment report, but it has been rising alongside U.S. interest rates. The 10-year yieldin the past week went from just above 2 percent to 2.33 percent Friday.
“The dollar index (this week) reached 80.12, completing a six week double bottom formation indicating the bull trend is resuming,” said MacNeil Curry, technical analyst at Bank of America Merrill Lynch.
A big catalyst for the interest rate move was the fact the Fed did not encourage the market to expect another round of easing in its post-meeting statementearlier in the week. Quantitative easing is also viewed as negative for the dollar, and it has been credited with pushing the prices of stocks and commodities higher. he Fed did upgrade its outlook on the economy slightly.
The Treasury market has also seen selling as pressures from the European sovereign crisis have lifted and markets attempt to normalize. Greece last week restructured its debt, qualifying it for another bailout.
“I think the importance of this bond yield back up is that it’s not happening in a vacuum. It is being driven by relatively stronger U.S. growth and by the equity market as well,” said Alan Ruskin, Deutsche Bank G10 currency strategist.
“I think it’s mildly positive. I think it’s more positive when bond yields are adjusting than afterwards. It’s not like the Fed is going to validate the bond market’s move,” said Ruskin.
The recent dollar strengthening is counter to a trend that had been in place, where the euro and stocks and other risk assets all rose, or fell, at the same time. Since the financial crisis, the dollar would rise only when the markets were gripped by fear.
“It’s almost like the euro is becoming the new dollar. We had this environment where if the market was calm, the dollar had a tendency to just kind of grind weaker. I think that’s how the euro will trade now,” said Nordvig.
European officials helped calm the markets, spurring the latest leg of the stock market rally, when they launched the first leg of a new liquidity program in December.
“I would not be surprised if the overnight rates in the euro zone stayed at zero for the next several years…I think the euro is gradually becoming the main funding currency globally. The euro move could be a much longer term thing,” Nordvig said.
As for the dollar, he expects to see a quick 2.5 percent move higher in the dollar index, to test its December high of 81.50. It was trading at 79.80 in mid-afternoon Friday.
“We do think this is a time for the dollar. We think it will last through the first half of the year,” said Robert Sinche, head of global currency strategy at RBS.
Sinche said unlike last year, the dollar may have a chance to hold its gains. One positive is that markets are not facing a high level of commodity inflation, as they did last year. Also, a year ago, markets and the global economy were hit by the impact of the Japanese earthquake and tsunami. That was then followed by the tightening of financial conditions, due to Europe’s debt woes.
Nordvig said the dollar’s run could be relatively short. He also said the dollar could run into trouble towards the end of the year when Congress addresses budget cuts and taxes.
He expects the 10-year yield rise a bit further to 2.40, with a possible break out to 2.60 percent. “Then it’s possible the rhetoric from the Fed could be adjusted to talk that down again,” he said.
Curry sees a longer term move. “I do think the dollar rise in general is a longer term trend,” he said. “I just think there’s going to be different reasons for the dollar rise. I like the dollar into year end.”
“Bigger picture, I think it’s going to trade up to 87-88 area, back towards the highs put forward in 2010,” he said. “Part of that is due to the euro which is big part of the dollar index. If you look at the euro, the trend is down for the euro. I still think it hits its 1.26 low.” The euro Friday was higher at 1.31.
Curry said the dollar could revert back to a trade where it moves higher in a risk adverse environment. He said the catalysts to that could be higher energy prices, or typical seasonality where stocks tend to sell off later in the spring, after moving higher earlier in the year.
He also said U.S. fixed income volatility feeds over into hedges. “Guys who are very long will start to pare back their emerging markets fixed income positions,” he said. That prompts selling of those currencies against the dollar.
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