The USD index can be down due to the US administration’s interference with the Fed’s activities

In spite of euro success in late June, resulted from the EU agreement on migration, the US dollar finished the second quarter up. The USD index added 5.2% and closed all three months in the green, it is the first time since 2016. Divergence in monetary policies and different pace of the economic expansion drew the greenback 5.5% up against euro. If the poor statistics broke down the ECB plans to restore the euro-area economy, the USA featured perfect health.

According to Atlanta Fed, the US GDP in March-June grew 3.8% faster. Macroeconomic Advisers believes the indicator to be 4.8% up. Only once in 35 quarters after the recession the predicted value was higher. At the same time, the Eurozone core inflation isn’t growing more than 1%, which suggests a weak internal demand and makes the ECB continue its ultra-easy monetary policy. Yes, consumer prices were up in June, at 1.9% Y-o-Y; however, it resulted rather from a sharp rise in oil prices. Different pace of economic expansion supported the inflow of $3.2 billion into the US-focused investment funds in the second quarter. The outflow from the European counterparts was about $25 billion.

There is an idea in the market that one of the growth drivers for dollar is trade wars that increase demand for safe assets, cut the US trade deficit and set back global economic growth. I think trade wars, on the contrary, hinder the USD index, because of the pressure on Treasury yield. Yet, the imposed tariffs don’t exceed 4% of the US import and 0.5% of the GDP. Nevertheless, the EU threatens to retaliate on the tariffs on the European car imports ($330 bn in 2017) to introduce the tariffs worth $300 bn. And that is 19% of the US export. China isn’t also willing to put up with Donald Trump protectionism. Many Bloomberg experts see the 3.3% drop of yuan against dollar in June, the worst one since China’s exchange market appeared in 1994, as a revenge for import tariffs. In fact, according to Morgan Stanley, Beijing will hardly allow the USD/CNY pair to continue rising, which can result in serious problems for the emerging markets. I’ll only note that yuan is only a little down, compared to the currency basket.

Dynamics of yuan and emerging markets currency index

Source: Bloomberg

Dynamics of yuan against dollar and currency basket

Source: Financial Times

According to BNP Paribas, another growth driver for the USD index is the capital repatriation. According to the bank, it was about $169 bn in the first quarter. On the contrary, verbal interventions can set dollar back. The president’s top economic adviser Larry Kudlow violated the White House’s 25-year principle of non-interference in the Fed’s activities and recommended the central bank to hike the rate as slowly as possible. So, EUR/USD starts the third quarter with a mixed sentiment, trying to find out the borders of the middle-term consolidation.

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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