Influences on USD are various; Five major factors include Economy, Policies, Politics, Trade and its Counter-Currency Economy. COVID has hard hit global economy and trade. All around the globe, interest rates decreased significantly. US unemployment have hit 14.7% in April (3.5% pre-COVID) and now stabilizing at 8.4% in August. GDP growth shrank for a second consecutive quarter by an annualized 31.7% in Q2. This is the biggest contraction ever, pushing the economy into a recession.
What drove USD lower?
As a response to the economic downturn caused by COVID, both US government and Federal reserve engaged in several policies. Congress is currently discussing the amount of relief bill. Democrats want a $2.2 trillion relief bill whilst Treasury Secretary Mnuchin wants to sign only $1.3 trillion. This stalemate pushed pressure on USD as it continued reaching lower levels this week, even pushing EURUSD to 1.20 levels and DXY to 92 levels.
The Fed will meet on September 16th where it is expected with a high probability of 93.2% (Source: Refinitiv) that they will keep rates the same at 0-0.25%. Furthermore, they will provide a summary of economic projections. The projections will come against the backdrop of last month’s Jackson hole meeting where Powell focused on “average inflation targeting” where he is giving flexibility to the Fed dual mandate of maintaining maximum employment and stable prices. With this measure, the Fed could keep interest rates lower for longer even if inflation is pushed above 2% (2% is the measure used to reflect stable prices). Current inflation is at 1% and therefore there is risk for economic instability (similar to 1982 debt crisis) in the near future if inflation gets out of control. This further pro-accommodative monetary posture (even during an eventual economic recovery) will ultimately lead to asset bubbles and therefore markets react by selling USD preemptively.
Another major factor contributing towards USD demise is the level of political uncertainty leading up to November election. COVID created complications as to how to vote. Further to this, President Trump is giving mixed signals to voters to vote by both mail and on location. Additionally, President Trump failed to contain COVID related deaths which now amounts to 190,000. BLM protests further complicate Trump’s chances of winning this year’s election. Polls are in favor of Joe Biden to win this year’s election but this is not a guarantee for economic woes to disappear.
US-China trade negotiations are still ongoing but many major issues are still unresolved. Phase-one trade deal is still in implementation phase. The attitude of current US administration is pushing China to diversify away from US-based economic structure. This further puts a dent on USD in the long run. Its status as safe-haven currency might diminish.
Other countries monetary and fiscal policies pushed USD to devalue as well. EU agreed on the Next Generation EU Fund (EUR 750 Billion) together with the Multiannual financial framework (EUR 1,074 Billion). This assisted in mitigating some of the political risk between EU countries. Although NG is a good initiative and favored EUR, this negative impact on USD should be short-lived as there still are Euroscepticism threats arising from immigration, integration issues and Brexit negotiations. This has led to a temporary risk off sentiment where funds flowed from USD to EUR. Idiosyncratic European risk is still persistent and therefore current appreciation of EURUSD from 1.12 in July to 1.20 in September might reverse.
Lastly, less global demand for oil means less global demand for USD. Oil price is being artificially buoyed by limiting supply from OPEC+.
What could drive USD higher?
A COVID vaccine will surely lift up markets. Investors are additionally focused on the success level of administrating the vaccine to the population and whether economic activities can continue unhindered. Easing political risk and a smooth US election would surely favor the USD. Once the economy picks up, investors will look to the Fed to see if rates will increase. This is tricky as stated above since the Fed made its dual mandate more flexible. Interest rate cuts outside US will push investors to purchase USD to seek safe-haven and better interest, leading to its appreciation. If China economic growth recovers and continue its upward trend then US imports from China would surely increase and thus would lead to USD appreciation.
• If economy recovers, USD increase
• If policy uncertainty decrease, USD increase
• If political uncertainty decrease, USD increase
• If US-China negotiations succeed, USD increase
• If Counter-economy (especially EU) risks increase, USD increase
• If Risk-off sentiment creeps into the market, USD decrease
• Higher oil global demand, USD increase
With the Fed changing its dual mandate, it is highly debatable whether USD will gain in the near future. Various systematic and idiosyncratic risks are still present. If idiosyncratic risks abate we can expect DXY to reach and even exceed 103 levels. A COVID vaccine might net out the impact on USD (economic recovery vs risk off sentiment) so it should not have a large effect.
With both foreign and domestic pressures on the currency, it is difficult to determine the path of least resistance for the USD. Since the beginning of the year USD is losing value against SEK, CHF, DKK, EUR, JPY and PLN. Emerging market currencies have almost all weakened against USD. A cheaper USD helped in propelling the stock market to very high levels. Towards end of year, for P/L reasons, investors might realize their gains by selling their assets and converting to their domestic currencies.
Weekly DXY shows the price breaching all Fibonacci retracement levels almost reaching 88.5, 2017 levels. This depreciation in 2017 was due to EUR strength so as already mentioned, counter currency strength or weakness plays a major factor in determining USD direction. A democrat win this November could lead to a reduction in challenges faced by US. This could restore DXY to its 2019 levels. RSI level illustrates an oversold USD which is a bull signal. On the other hand, EMA 50 (red line) is crossing over downwards on EMA 100 (green line) which is a bear signal. Chart shows potential for price pullback to EMA 50 (red line)
End of 2020 might mean a weaker USD even if technicals show otherwise. USD will most probably be range bound in 2021 with DXY offsetting between with a potential economic recovery and further headwinds.
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