Jameel Ahmad
Jameel Ahmad

Dollar bulls and the divergence trade

By Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM

Back at the end of January, after the Federal Reserve downplayed the monetary policy outlook in the United States and struck a dovish tone, markets pushed back expectations for the next US rate hike and priced in a weaker Dollar as the base case scenario for 2019.

Yet, since Fed chair Jerome Powell’s press conference on January 30, the Dollar Index (DXY) has gained by some 1.7 percent, and the Greenback has strengthened against most G10 currencies.

So, why is the USD still the most favoured G10 currency? Simply put, the United States remains in its place as the sole bright spark among developed economies.

Even though February’s non-farm payrolls came in well below market expectations, the trend remains intact: 101 consecutive months of job gains. The data also heralded the sharpest gains in average hourly earnings in a decade. January’s retail sales suggest that December’s slump was a one-off, and that US consumers can still be relied on to support growth momentum in the world’s largest economy. While GDP moderated in Q4 2018 as the effects of fiscal stimulus get phased out, a 2.6 percent expansion is still well above what many other major, developed economies can provide.

In contrast, Europe’s outlook for 2019 has deteriorated, prompting the European Central Bank to step in with another round of stimulus earlier than expected. Given that the Euro accounts for more than half of the DXY weightage, the DXY should remain supported by Europe’s economic woes and the downbeat expectations on the Euro.
Sure, the Pound has gained 0.85 percent against the Greenback since the end of January, amid renewed hopes that the United Kingdom may avoid a no-deal Brexit. However, uncertainty continues to underpin the UK’s political outlook, adding pressure on the Sterling along the way.
Japan’s growth and inflation numbers remain sluggish, with the added uncertain economic ramifications from its expected sales tax hike in October. Overall, the OECD has downgraded its global growth forecast to 3.3 percent for 2019.

When scouring the global terrain, with potential landmines both seen and unseen, investors may be tempted to play it safe and seek refuge in the arms of the Dollar. Should the US economic releases continue churning out positive numbers, the Fed may have to resume its rate-hiking cycle, in adhering to its ‘data-dependent’ stance. All this points to continued Dollar strength as a theme moving forward.

To be sure, there are risks to continued Dollar gains, such as the anticipated US-China trade deal providing risk-on sentiment a leg up. But here’s the bottom line - even if the US economy slows down and the Fed’s tone maintains a downbeat outlook, the US economy will by most accounts remain far superior to its developed peers. On the balance of what’s evident at this point in time, it appears that Dollar bulls have an easier task proving their case; at least for the time being.