Sterling was trading at $1.67 at the beginning of last week and was set to push $1.70, but it is now trading below $1.63. The euro/dollar rate was over $1.49 a week ago, and is now trading below $1.42. What has the dollar done to deserve such a pull back? Nothing really.
Lat week, Trichet dealt the euro a blow by effectively ruling out an ECB rate rise in June (though July remains a good bet). This saw speculation on further near-term ECB tightening unwound, which helped the dollar. More importantly we heard various news stories of a Greek euro-exit and rumours of a Greek debt restructure, which saw the dollar benefit from strong safe-haven inflows. In addition, commodities prices slid horrifically, and whilst they stabilised in the early part of this week, they have had another bad day today.
There are also growing concerns over global growth, caused by a slow in output from China and monetary tightening from the Peoples Bank of China. With risk appetite well and truly hemmed in, global stocks have fallen and which asset stands to benefit from all this? Safe-haven currency, one of which is the dollar. Gold usually benefits from such widespread uncertainty but a sharp slide in the precious metal is a key contributor to the current environment.
So the dollar is doing well now but should we adapt our forecasts as a result? Working in the dollar’s favour moving forward is that the Federal Reserve’s QEII programme will be brought to an end in June in all probability, which has been a major source of the dollar’s long-term weakness. Assuming eurozone officials reach some sort of agreement with Portugal and Greece over their debt crises (probably in the form of some unsatisfactory bailouts which will only delay disaster, but will calm the markets for now), then confidence should return. Commodity prices seem very likely to bounce back.
I see monetary policy returning to dominate currency movements. Whilst the Fed may be ending QEII, it seems unlikely to raise rates this year and is behind the BoE and ECB. US growth is certainly nothing to get excited about, as shown by today’s disappointing US retail sales growth. So for at least the next month, I expect sterling and the euro to regain the front foot from the dollar (provided the eurozone debt crisis reaches some sort of solution!).
Richard Driver
Analyst – Caxton FX
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