US dollar strengthens as geopolitical risks ease
With the markets poised for more volatility, the greenback could take off even more
It’s been a wonderful week for greenback long positions, with the US Dollar Index closing at three-month highs on Monday. From April 17 until April 23, the Index gained 1.77 per cent in five trading sessions and has comfortably closed above our upper resistance level of 90.50. The Dollar’s mini renaissance is due to a couple of different factors aligning simultaneously. Easing geopolitical risks, stronger US yields and improving US data combined with weaker global data have seen the dollar take off in the short term.
The last time I wrote, President Donald Trump was gearing up for what seemed like a trade war with China. While those fears have greatly abated, the dollar and equity markets have rallied in the short term. We already saw the president take aim at a new global heavyweight, Opec, when he said that they were keeping oil prices artificially high.
While the recent uptick would have squeezed out weaker US shorts, stronger US short positions would be abreast of the potential for upcoming uncertainty. In my last column, the VIX - an index on the Chicago Board Options Exchange which measures the stock market expectation of upcoming volatility - also known as the “fear gauge” was above 20 levels (the highest in two months). And while we have seen the index drop to below 15 levels in the past two weeks, the move back towards 17 indicates that markets are poising themselves for another bout of volatility that could see more upside moves in dollar assets.
The dollar has also been a big benefactor of the recent upside move in US treasury yields. Over the same period, from April 17 to 23, yields have moved from 2.8 per cent to testing 3 per cent levels. This direct correlation has seen money pouring into US assets and has seen the yield differential widening between US and European, and US and Asian government bonds. This also explains the recent weakness in forex pairs such as the EUR/USD, GBP/USD and USD/JPY. While US yields are improving, their counterparts remain stable and this widening yield differential is seeing hot money pour into higher yielding assets. This logic works particularly well in calm market conditions - calm with no geopolitical risks - however, with the current administration anything is possible and this trade could be short lived.
Read more from Gaurav Kashyap:
As a result of this recent dollar strength, EUR/USD on the Dubai Gold and Commodities Exchange (DGCX) has dropped from 1.24 levels to its current 1.22 over the same time period. Technical studies suggest we can expect to see short-term consolidation at the current levels, however I feel there is more room for downside with a move towards 1.2050 level in extension in the next few weeks.
The European Central Bank is convening to announce rates this Thursday and I would not expect a too hawkish approach. On the contrary, the tone should weigh more dovish with the recent poor run of EU numbers. The head of the German Bundesbank has said recently that the economic conditions in Germany during the first quarter have not been brilliant and this is amidst already deteriorating overall EU numbers. Therefore, do not expect ECB chief Mario Draghi’s outlook to improve significantly; instead he will adopt a more conservative tone with regards to the end of their existing quantitative easing programme.
The Japanese yen has also weakened to multi-month lows against the greenback on the DGCX – and this cross has been particularly impacted because of the improving risk sentiment. Watch for upsides in the USD/JPY cross to be capped at 109.62. And finally, gold has been weaker during the recent dollar rally - this perhaps presents the safest long opportunities against a rampant dollar. A move towards 1319 levels may provide good long value, however, an entry at 1308 would provide the best value.
Gaurav Kashyap is a market strategist at Equiti Global Markets
Updated: April 24, 2018 02:12 PM