This Is Why The Dollar Will Rally This Year

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This Is Why The Dollar Will Rally This Year

Wage Inflation Will Move The Dollar

The US non-farm payrolls report was released today and was much as expected. Job gains were strong, unemployment is low and wages continue to rise. While several points within the report were tepid compared to expectation there is one that will move the dollar; average hourly earnings. Average hourly earnings rose by 2.9% in the past month and show no signs of abating.

The NFP shows an increase of 204,000 jobs that, with revisions to the previous month, has resulted in average gains of 185,000 over the past twelve months. Based on other data points from the labor market this trend is going to continue at least into the end of this year. The labor market is tight, there are far more jobs than workers, and that means one thing; upward pressure in wages and that is what we are seeing.

Regarding forward outlook, the Index of Leading Indicators has been positive for more than two years and came in above expectation at the last read. This, along with increases in both the manufacturing and services sector PMIs, points to accelerating growth in the second half of this year. Accelerating growth is a situation that will add upward pressure to wages as employers do whatever it takes to attract and retain employees.

The key takeaway is that wage inflation is running near 3.0% and well above the Fed’s target rate. While not the only input regarding core US inflation it is a very important part of the picture. Core inflation has been on the rise this year and will soon cross the 2.0% level. If the FOMC wants to curb inflation they will have to act to control economic growth and that means rate hikes, more rate hikes than what the market had been expecting.

The EUR/USD fell hard on the news, shedding more than 50 pips in a matter of minutes to create a long red candle on the daily charts. The move has confirmed resistance at the 1.1625 level and may take the pair down to support targets near 1.1525 and 1.1400. Next week there are a number of US data points including the PPI, CPI and FOMC Beige Book that could add downward pressure to this trade.

4 reasons why the US dollar is unlikely to rally this year

The US dollar has been the whipping boy of currency traders over the past year.

In 2020 alone, the US dollar index, or DXY, fell by 10%, losing ground against all major currencies. And that weak performance has carried over into the early parts of 2020 with the DXY down a further 2%.

However you chose to describe it — be it relentlessly, monotonously or other — the US dollar has come under significant selling pressure.

Put simply, it just can’t find a friend.

Elias Haddad, Senior Currency Strategist at the Commonwealth Bank, says the US dollar is unlikely to find many new friends in the year ahead, either, but thinks the chances of a short-term bounce in the DXY are increasing given market sentiment and positioning are all stretched in the same direction.

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“The USD is vulnerable to a technical relief rally in the short-term but we continue to expect the USD to trade on the defensive this year,” he said in a note released earlier this week.

In particular, Haddad nominates four specific factors that will likely weigh on the greenback: weak inflationary pressures, further rate hikes from the Fed already factored in to the dollar’s valuation, a move towards less accommodation monetary policy settings from other major central banks and an improvement in the global economy, something that tends to weaken, rather than support, the DXY.

On the inflation outlook, Haddad says soft inflationary pressures will not allow for markets to price in additional rate hikes from the Federal Reserve.

“Benign US inflation pressures will limit a significant upward revision to US interest rate expectations,” Haddad says, noting that the Fed’s preferred inflation reading — the core PCE deflator — has been below the Fed’s 2% objective since May 2020.

“Interestingly, the FOMC still projects the core PCE deflator to only reach 2% in 2020 even when accounting for the prospect of greater fiscal stimulus.”

Along with weak inflationary and wage pressures, Haddad says the US dollar is unlikely to get much support from further rate hikes from the Federal Reserve.

“Fed funds rate rises are largely priced,” he says. “Fed funds futures have fully discounted two 25bps rate hikes for 2020.”

And even if the Fed is more aggressive, delivering three hikes as it did in 2020, Haddad still doesn’t think it’ll be enough to support the dollar.

“The FOMC can potentially deliver three 25bps rate increases this year. But one more rate rise than is currently priced-in will not be a major sustained tailwind for the USD,” he says.

And with each rate hike from the Fed taking it closer to the end of its monetary policy tightening cycle, Haddad says other major central banks are just embarking on that path, something that he expects will continue to support other major currencies to the detriment of the dollar.

And that’s especially for the euro, the largest component in the US dollar index at well over 50%.

“There is greater scope for less monetary policy accommodation from other major central banks,” says Haddad.

“For instance, Eurozone overnight index swaps (OIS) show just a 30% probability of a 10 basis point lift in the European Central Bank (ECB) deposit rate by year end to -0.30%.”

Haddad says that interest rate expectations from the ECB “can adjust higher sooner because leading indicators are consistent with firmer Eurozone GDP growth and accelerating inflation”.

Further aiding other major currencies, Haddad also says that sychrnoised and strengthing global growth should also act to support cyclical currencies such as the Australian, New Zealand and Canadian dollar’s.

“The global economy is experiencing its first synchronised expansion since 2007,” he says.

“[This] chart shows that the USD tends to underperform when global growth is improving. Stronger global growth will support commodity prices which bodes well for AUD, NZD and CAD.”

As for the risks to his downbeat view on the dollar, Haddad says they come from a sharp increase in financial market volatility or significantly faster tightening cycle from the Fed.

“A faster pace of Fed funds rate hikes and/or a pick-up in financial market volatility are upside risks to our bearish USD view,” he says.

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This is the U.S. dollar’s fastest rise in 40 years

The U.S. dollar is incredibly strong again, but no one predicted it would beef up this quickly.

America’s greenback is enjoying its fastest rise in 40 years, according to Citibank ( C ) . Over the past eight months, the U.S. dollar has strengthened dramatically against all the world’s other major currencies.

Don’t expect that to change any time soon. Since the start of 2020 alone, it’s gone up in value about 14%, according to Bank of America ( BAC ) Merrill Lynch.

Why the jump? The dollar’s rise is a direct result of America’s strong economy while other parts of the world struggle. Europe is enacting a new stimulus program to revive its economy, and Japan is also in stimulus mode.

Travelers are familiar with exchange rates and how they can impact the cost of goods. But the strong dollar’s impact goes well beyond travel. It effects everything from gas prices at the pump to the profits of America’s big businesses that sell things overseas.

Many corporations such as Coke ( KO ) and Boeing ( BA ) warned that the strengthening dollar is harming their bottom lines, especially in Europe.

The euro’s big slide: One euro is now worth $1.05 — its lowest level since 2003. This exchange rate was unthinkable only a few years ago when one euro was worth $1.37 and some predicted the euro could even replace the dollar as the global currency of choice.

But you might want to wait a little longer to book that European vacation: the euro could be below $1 sometime in the next year, according to a Goldman Sachs ( GS ) report. They forecast one euro going as low as 80 cents by the end of 2020.

The dollar’s fast paced rise has convinced many that the rally won’t end anytime soon.

“Speed does matter,” says Steven Englander, managing director of fixed income strategy at Citi. “What’s going to stop the dollar from continuing to make these gains?”

What’s ahead: America’s economy certainly won’t stop the dollar’s surge. The job market is on a tear, growth is picking up and the Federal Reserve is likely to raise its key interest rate this year for the first time in almost a decade.

At the same time, Europe’s new stimulus program is lowering interest rates across the pond. It’s a recipe for the dollar to gain even more value this year, experts say.

Outside of traveling abroad, the dollar’s impressive rise will have an impact at the pump. A strong dollar, coupled with an over-supply of oil, helps keep gas prices low, Englander says.

While cheap gas and affordable French wine sound lovely, the dollar’s record pace could be a negative for America’s big businesses. They will struggle to sell their products abroad because the strong dollar will make them too expensive for foreign buyers.

“If we continue to see the dollar appreciating this fast, it will be an issue,” Englander says.

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