Fed doubts dent dollar

In previous articles I mentioned that the dollar could gain further if there was a breakdown in the EURUSD through a key support level at 1.13. Well, that break did happen and the price did fall back, but only to as low as 1.1216 at the beginning of last week.

However, since then, the EUR has rebounded, not only managing to close back above 1.13 during the course of last week, but also extending those gains, to finish on Friday even higher at 1.1415. Now because the EURUSD is essentially a mirror of the USD index, it should come as no surprise that the USD index reversed backwards from a fresh 2018 high at 97.69.

The subsequent relapse through technical supports at 97.20 and then further through 96.75-80 is what led the price to drop back to a session low of 96.40 ahead of the weekend. The close on Friday, at 96.45 could hardly be described as immediately dollar positive either. So, why has the US currency come unstuck and so quickly after breaking out to the topside?

Well, quite simply it’s down to US yields falling following comments from the Fed boss, Jerome Powell who last week cast some doubt on the path of future Fed policy. The impact of those comments was further endorsed by remarks from other Fed members as well as the latest US inflation data, which evidenced a slight drop in October.

Furthermore, this is the first time in quite a few months that the Fed has delivered any resemblance of doubt to the markets in regard to the extent of future rate hikes. Consequently, the US 10 year yield has fallen back from a high of 3.26% in October, to close at 3.06% on Friday- its lowest weekly closing level in almost 2 months.

Unsurprising perhaps then, to see the lower close there coincide with a move higher in the EURUSD, conversely ending at its highest level of the week on Friday. Despite this, the markets are still expecting another US rate increase next month, but a lot will now hinge on what the Fed has to say regarding future action, assuming they do actually deliver that increase on December 19th.

On the other side of the pond, the situation in Europe shouldn’t be ignored either because there are it seems, rising political headwinds here. Leaving aside Brexit for one minute; there are serious political issues unfolding at the core too, namely in France, Germany and Italy.

Merkel is on her way out, Macron is looking weaker by the minute and Italy continues to face off against Brussels over its budget and in all three countries the far right is on the rise again. Just this weekend we saw violence erupting in France, with Greece back in the news for the same reasons too.

Hence, Europe is dogged by political unrest and that’s ultimately going to keep investors nervous, even if some of them have temporarily moved away from the dollar. The main reason for that move I think is down to relative value- the dollar at EUR 1.10 or even 1.15 is for sure expensive and so when there’s an excuse to cut dollar longs (as seemingly provided by the news last week that I just mentioned), then perhaps it’s entirely understandable. The question therefore is how much further can the dollar weaken before it starts to look attractive again?

Well, my best assessment of that would be to say; that all the time the EURUSD remains below 1.1815 (September), then the longer term up trend for the dollar is still very much intact and fresh EUR sellers will re-emerge at some point, so long as that topside remains unbroken.

However, should the EURUSD post a close above (its still falling 200 day moving average), currently and coincidentally at 1.1809, then the dollar rebound from the end of Q1 this year could be in doubt. The first sign that such a move might be on the cards would be a sustained break back above 1.1600.

Beyond that outlook and in the short term, perhaps the best guide to where the dollar and the EUR might be headed (leaving aside any potential GBP impact on both) is probably to keep a very close eye on those US bond yields. Whilst often decoupling from each other in the past, recently they have become quite close bed fellows again.

To better see what I am talking about, please take a look at the chart (taken as of the close on Friday) below which shows the price of both over the past month and where you can see just how closely they have started to track each other again in recent days.

The white line on this chart denotes the price of the US 10year bond which as you can see rose quite sharply last week. Quite simply, if the bond price rises, then yields fall and vice versa of course. The yellow line denotes the price of the EURUSD which as you can see, has risen too and hence tracking price closely. Indeed, as I just said, a lot more closely that it had been previously. I hope that all makes sense?

Finally, a very brief word about the pound. It’s still potentially in deep trouble and entirely hostage to how things pan out here in the coming days. There’s really nothing more to add just yet, beyond what I said last Thursday, but if there is anything of consequence, then I will post something here as soon as I can.

Key Data releases due this week

20/11- 12.30am Reserve Bank of Australia releases minutes of November policy meeting

20/11- 11.00am UK CBI November Trends- total orders and selling prices

21/11- 1.30pm US October durable goods orders

21/11- 11.30pm Japanese October CPI inflation report

23/11- 1.

30pm Canadian September retail sales and October CPI inflation report

23/11- 2.45pm US November Manufacturing and services PMI data