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US Dollar Ripe For Recovery

International | Sep 14 2017

By Kathleen Brooks, Research Director, City Index

Why the US dollar looks ripe for a recovery, on paper…

The dollar index’s steady decline has been one of the most reliable trends so far this year. From a technical perspective, although the dollar has attempted to claw back some recent losses, the mountain to recovery is steep and from a technical perspective, the downtrend in the dollar remains deeply entrenched. USD/JPY is looking more hopeful, but the fact that the buck could not capitalise vs. the yen during the peak of the North Korea crisis, even when Japan was so close to the epicentre of the problem, speaks volumes for the attractiveness of the dollar at the moment.

However, on paper things are starting to look more optimistic for the dollar:

  • CFTC speculative positioning showed that dollar shorts had risen to their highest level since early 2013, this can be a sign that a change in trend is on the horizon.
  • US Treasury yields have had a rip-roaring couple of days, with the 10-year yield rising nearly 10 basis points. US Treasury yields normally have a strong positive correlation with USD/JPY. In the last year the correlation between 10-year yields and USD/JPY has been a significant 0.71.
  • Economic surprises from the US have recovered, and a few more better than expected data releases later this week could see positive surprises start to outpace negative surprises.

How to get the dollar moving again…

The question now is, how to translate this into a stronger dollar. Bloomberg recently quoted some research and found that growth downgrades can have a big impact on a currency, which is one reason why the dollar has been under pressure in 2017.

It also noted that the USD has tended to depreciate more against currencies that have seen larger upward estimates to their 2017 growth forecasts. Thus, the euro, SEK, SGD, CAD, HUF and PLN have all had growth upgrades at the same time as outperforming the USD. This also goes some way to explain the more lacklustre performance of the GBP vs. the USD (although the pound has started to come back to life recently), as the UK has been mired in concerns about its economic outlook post Brexit.

Boring fundamentals – the key driver of the dollar

Thus, perhaps the key for the dollar is not yields or economic surprises, but an actual economic upgrade from an economic body such as the IMF or World Bank, which could give the speculative community a reason to buy the dollar. When the trend in the CFTC data shifts that will be a clear sign that things could be about to change for the buck, see the chart below.

Without this fundamental impetus, the dollar could struggle to get back even to early September levels.

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