In Q2 2017 the Euro was able to rise by 7.2% against the USD, which is the best dynamics since July-September 2010; at the same time USD index, showed the worst result for the last six years, which increases possibility of the termination of the "bullish" trend for the USD. Strong pressure from the central banks - competitors of the US Fed has stopped the divergence in the monetary policy, which has been lasting since 2014, thus, depriving the USD of the most powerful driver of growth. As a result, hedge funds now believe that the USD index will be in a downtrend and for the first time since May they have acted as net sellers of US currency in the futures market.

 

Dynamics of the trade-weighted dollar index

Source: Wall Street Journal.

 

In fact, the euro has many advantages. The defeat of Euro sceptics in Netherlands and France has reduced political risks and contributed to the inflow of capital into the ETF, which was also helped by the fact that European GDP was higher than in the USA, which happened for the first time in the last few years. The laws of fundamental analysis prove to be valid. One of these laws states: strong economy = strong currency. We can see that the USD now is at the very tail end of the G10 due to the fact that the American GDP is lower than that of the competitors.

 

The ECB is going to stabilize monetary policy in the shortest possible time. If the Bank does not take measures soon, serious imbalances with the Federal Reserve may begin as early as in 2018, which would lead to increased turbulence in financial markets. It seems that if the policy of monetary restriction will be accepted by all the Central Banks, it will slow down the process of deterioration of the financial conditions. The US Fed has gone through the similar phase in 2015-2016. In this respect, a coordinated measure of tightening monetary policy by Portuguese Sintra is favourable for all the parties. The process has already been called as "Sintra Pact" by the sharp tongues.

 

At the same time, latest European inflation statistics has dampened enthusiasm of EUR/USD bulls to continue the rally. The decline in consumer prices in June forced investors to reconsider Mario Draghi’s words. Although the head of the ECB stated that monetary policy can be stabilized soon, macroeconomic statistics shows that the European regulator will not rush to take measures.

 

Note, that the resistance of the USD against the strong data and the fall in USD after the release of the weak data can eventually cause a pullback. This does not kill but makes us stronger. There is too much “bullish” news for EUR / USD in the recent publications. In addition, the underestimation of the USD in terms of bond yield differentials and the probability of monetary tightening by the US Fed in 2017 can play a good service to the USD.

 

Dynamics of the USD and the US economic surprises

Source: Bloomberg.

 

Meanwhile, the main currency pair is in anticipation for the release of the minutes of the June FOMC meeting and the data on the US labor market. The price has frozen in the range of 1.139-1.1445 awaiting new drivers, which may move the pair to action.

 






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.



Written by:

Dmitri Demidenko

Independent analyst

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