Having been a dollar bull for several months, Bloomberg’s Mark Cudmore now thinks it’s about time for the long-term dollar downtrend to resume. All the key drivers of strength have run their course and it’s more likely that the marginal developments from here will weigh on the dollar…
After rising more than 4% in the last five weeks, the Bloomberg Dollar Spot Index has bounced far enough.
The climb has been entirely justified by fundamentals but now the key drivers are beginning to turn the other way.
U.S. two-year yields last week hit an almost-decade high, but Wednesday’s FOMC minutes confirmed there’s a very high bar for accelerated rate hikes. With two-year yields trading more than 80 basis points above the Fed Funds effective rate, there’s no upside left in the short-term.
It’s not just front-end yields where dollar support is being eroded. All the way out the curve, yields are falling. Treasuries had been attracting increased FX-unhedged purchases from Asia, but those inflows will now dissipate again.This is happening as yields elsewhere have been rocketing — even if for the wrong reasons. Unless you believe the global economy has deteriorated radically, then emerging market bonds and European bonds look a lot more attractive than they did one month ago.
Trade tensions have supported dollar strength, but that theme has played out in full. Trump’s recent back-and-forth on the China agreement has undermined the U.S. negotiating position. That makes the marginal development from here more likely to be dollar negative.
The Libor-OIS spread was never a sign of bank funding stress, but it was making it more expensive for many international banks to be caught unintentionally short of dollars. The spread peaked out at 60 basis points almost seven weeks ago and has retraced substantially since then.
Now that Italy and Turkey have put fiscal sustainability back on the radar, the long-term gradual unwinding of structural dollar exposure will likely resume because of the U.S.’s twin deficits.
Like any change in an established trend, dollar weakness may initially be accompanied by risk-aversion but it will ultimately be seen as a positive for global risk markets.