CNBC reported that US stocks went down slightly today because of the difficult trade talks with China, and the ongoing political turmoil in Italy. Although the drop may seem like an inconsequential decrease, it has sent negative signals.
There had been a lot of uncertainty in the market for about two weeks now, and investors are wary as it’s probably downhill from here for the greenback. “Where we are right now is markets are trying to figure out whether or not they want to take the dollar higher,” said Mark McCormick, the North American head of FX strategy at TD Securities in Toronto.
However, McCormick did not seem optimistic as he said that “the pace of the dollar move is likely to subside from here.” Morgan Stanley strategist led by Hans W. Redeker shared in McCormick’s pessimism of the dollar market when he said, “The dollar has entered a secular bear market, which we think is likely to remain in place for some time.”
The fear in the dollar market is fueled by the possibility of a growing US twin deficit. Raising budget and trade deficits may help bolster the growth of the US economy but at the expense of higher returns on dollar-denominated assets which is projected to weigh against the dollar. Redeker says that “a persistent dollar rally is unlikely as the twin deficits crowd out private investment by raising borrowing costs.”
Just last month, the dollar experienced a reversal of fortune as it surged against the euro turning investors bullish towards the dollar. While analyzing what’s behind the dollar surge, Nicholas Spiro rightly said that “The world’s financial markets are influenced by a multitude of factors, which is why it is a mistake to place too much emphasis on one particular development or trend.”
The performance of a currency should be measured against the backdrop of the basket of currencies in the market. This is what happened when the euro fell 4.3 percent against the dollar last month, reducing its nearly 60 percent advantage against the dollar.
During the major part of last year, the dollar index still fell 11.5 percent despite the four hikes in interest rate between March 2017 and March 2018.
According to Bank of America Merrill Lynch Head of Global Rates and Currencies Research, David Woo, what was weighing against the dollar since a major part of last year was what he called “interest insensitive FX flows”. He laid particular importance on two of such flows – cross-border equity flows and reverse diverse diversification which were a huge problem for the dollar vis-à-vis the euro. For this reason, there was no interest in investing in the greenback.
The deterioration in the European economy was what gave the greenback the long-awaited boost making April the best month the dollar enjoyed since Donald Trump’s election as President in November 2016. This looked like a sign of bearish times for investors in the euro however with a drop in the value of the dollar on Monday such projection seems unlikely.
Stephen Gallo, European head of FX strategy at BMO Capital Markets, said in a research note that the euro could rise to $1.30 in the next 12 months. The drop in the value of the greenback and the buying support from central banks are working in favor of the euro and it is highly possible that it will reach the targeted projection.
It is too early to fall back on those projections, given the reports that the incumbent Italian government will seek debt forgiveness from European creditors to the tune of €250 million. This news caused the euro to slide below $1.18 on Italy debt concerns which is the lowest since December 2017.
Despite the depreciation today, I believe the dollar would still make a comeback. Only time will tell how far the dollar will go.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.