Fed digs a hole for the dollar

The dollar added 0.1% by the European open, having almost completely recovered from the decline the day before. The recent pull into the dollar is well matched by the slippage in stock markets.

Since the start of last week, the S&P500 has slowed markedly and turned to decline by the week’s end. A corresponding decline in the futures followed a 0.3% gain on Monday. The Nasdaq100 has fallen for the 4th straight trading session, dragged to the lows of April.

In contrast, stocks in the Dow Jones index are gaining more investor interest, on a renewed rotation from growth stocks to value stocks.

Earlier in the year, a similar rotation from growth to value stocks helped the dollar gain ground against its major rivals. The willingness of traders to lock in profits in names that have rallied strongly over the past 12 months could support a corrective rebound in the dollar in the coming days.

On the tech analysis side, a 0.4% rise in the Dollar Index to 91.5 from 91.1 now would fit within the framework of a rebound after April’s decline. A move higher would further strengthen the dollar.

However, in our view, the US Fed’s desire to maintain an ultra-soft monetary policy together with massive stimulus measures from the government is digging a hole for the dollar.

Americans have received vast amounts of money on hand over the past 12 months. And these funds are not only already working in the economy (as can be seen in the recovery of jobs and high activity in the industry), but they are also feeding foreign business, reflected in record deficits in the balance of goods. In other words, dollars are flowing abroad, creating a drag on the value of the US currency against competitors from emerging countries.

This is counteracted only by the reflex pull of financial markets into dollars on the slippage of equity indices. But this reflex cannot be sustained for a long time. Europe and Japan have a larger proportion of value shares, which can divert part of the flows into them. Emerging markets and commodities are the beneficiaries of the retail demand boom in the USA. In this regard, the markets may well continue the trend of selling the dollar on the growth.

The FxPro Analyst Team