The fact that the dollar is rallying at a time when the US economy is weakening is a sign that the foreign exchange market has been turned upside down, according to HSBC’s David Bloom.
"The FX market to some extent has been turned upside down and the concepts we used to assess the dollar , and other currencies, have had to be put on the shelf," said the global head of foreign exchange strategy at HSBC in a research note.
"Historically a weak US economy would have been seen as negative for the dollar. Since the crisis, the market has had to come to terms with new rules," he said.
Once going against the fundamentals would have been a very bad trade, but Bloom believes the fundamentals might be changing.
"The confusion for the FX market is even greater when we take into account the US debtceiling issue and what it means for the dollar," said Bloom. "In the pre-crisis world, if the debt ceiling were raised to help offset a slowing economy by boosting fiscal spending, then it would be dollar supportive."
"In the post-crisis world, an increase in the debt ceiling will help reflate risky assets at the dollar’s expense," he said.
Loss of Primacy
Whilst the dollardoes not appear to be trading on the fundamentals, Bloom believes the fundamentals have simply changed.
"The 'fundamentals' used to say that the dollar had primacy, but now the US dollar behaves like a residual currency," he said. "Many are suggesting that fundamentals are no longer relevant but we disagree. Fundamentals are working; just in a different manner."
Citing the example of how the dollar used to be driven by trade data in the 1980s before financial flows of money became the primary driver in the 1990’s.
"In the post-2007 environment, risk and emerging markets have become ever more important, and the way in which we look at things has significantly changed compared with the pre-crisis environment," he said.
"It is not that the 'fundamentals' do not work, but rather the world has changed and the dollar no longer has the primary position it once held," said Bloom.