Good Morning,

A deeper dive into the recent behaviour of the US Dollar, courtesey of my colleague Craig Johnson….

‘Buy dollars, wear diamonds.’

This was the old adage that circulated in the FX markets of the 80’s and 90’s.  What did it mean? Essentially, being long the greenback would treat you right as a general rule of thumb.  However, the dollar has lost 7 cents in a calendar month against the Euro. Even Sterling, as the sick man of the G10 has managed a more than decent run. Breaking out the range and appreciating 6 cents since 20th July to levels approaching the pre covid highs before the March depreciations.

July 2020 was officially the worst monthly performance by the dollar in 10 years.  So it brings to mind the words of the Nixon-era US treasury secretary John Connelly. He famously stated ‘it’s our currency but it’s your problem’.
What now for the dollar outlook and why are we seeing this reaction?

Does the Dollar Index (DXY) tell us anything?
The DXY has been very strong over the recent pandemic.  It was seen as a flight to quality and continued the trend of dollar strength we have seen since early 2018.  This was when the FED began their rate hiking cycle. Now we have seen a sharp reversal.  Over the last 4 weeks.

Why now?

Well the first thing to say about this, is that it is mostly a USD move. The reason for it I think can be categorized in three broad topics.
Firstly, we have seen the yield play that that the dollar enjoyed wiped out. In March, in response to the coronavirus the FED slashed the base rate from 1.75% to 0.25%.  Wiping out the large advantage holding the Greenback offered compared to the Euro and the Pound.

Secondarily, we expect, despite Trumps announcement yesterday he is keen to postpone the election, there to be a Presidential election taking place in November. So adding another layer of risk into the currency.
Thirdly, we have the US response to Covid-19 which has been presented as haphazard and ultimately damaging for the US economy in the long run. In fact, US GDP shrunk 32.9% annualized in the second quarter of 2020.  This leaves large questions about how quickly the US Will recover and what a recovery will look like in a pre-vaccine world.

Positioning and Seasonality
A key factor beyond sentiment in FX markets is market positioning. We believe that dollar positioning isn’t over stretched against the Pound but may be approaching that against the Single Currency.  Probably not surprising given the aggressive moves this month.  We can also look at the seasonality in the USD and see if it offers some clues.

If we look back over the past ten years, we can see that June and July are seasonally periods of weak performance.  However, with August comes the promise of a new dawn and we may see a potential reversal in the USD fortunes.  We shall have to keep a watching brief.

The shift in sentiment has seen the USD become less favored as a safe haven and you could argue its place alongside the Japanese Yen and the Swiss Franc is under threat from the Euro.  However, I feel EURUSD is a bit stretched here so we may see a pull back before we build up a head of steam to try to take out the 1.2000 mark.
Sterling positioning against the dollar looks good so there many be more room for a continued run higher for sterling bulls. Also bear in mind, we have the continued specter of Brexit looming on the horizon.  Whilst it looks like talks will go to the wire, the base case for an UK-EU trade deal, excluding financial services will bid sterling once all is agreed.  Its possible that the long muted cable recovery that has been spoken about since 22nd June 2016 could be around the corner.

All charts courtesey of Bloomberg L.P


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