The trade-weighted USD is depreciating at the fastest pace in a decade. And that despite a strong U.S. economic performance that is encouraging the Fed to tighten monetary policy. Foreign investors could be apprehensive about growing protectionism in Washington and may not be as keen to finance mounting U.S. deficits which have historically been correlated with a weakening greenback. Even world central banks seem to be losing faith in the big dollar, with their USD share of allocated FX reserves now at a four-year low. All told, the outlook for the U.S. dollar is not rosy.
Who’s going to benefit from USD woes? It’s the euro according to speculators who increased their long positions on the common currency to a new record in March.
Uncertainties brought by inconclusive Italian elections ─ which point to an unstable coalition ─ did not seem to bother investors much. Perhaps that’s because the eurozone economy is doing well. After a banner 2017 when growth was the best in 10 years, the economy remained on an uptrend in Q1 based on solid Markit composite PMIs. Export powerhouses such as Germany and France continue to benefit from buoyant trade. Domestic demand is also improving on the old continent courtesy of a strengthening labour market and better credit growth. The European Central Bank’s extraordinary loosening of monetary policy during the crisis has clearly paid off, albeit with a lag. While the lack of inflation means the ECB will remain patient on rates, the anticipation of tighter monetary policy in late 2018 or next year could help push up the euro over the coming quarters, although unwinding of record long spec positions should somewhat restrain the ascent.
Despite the pick-up in world oil prices, the Canadian dollar is among the worst performing major currencies this year. As it turns out, the impact of unfavourable Canada-U.S. interest rate spreads continues to dominate and suffocate the loonie. Investors seem to be concerned about NAFTA renegotiations, the housing market (due to B20 regulations) and the sustainability of consumption growth (due to the heavy debt load of households). But if, as we expect, this fear factor diminishes over the coming months, USDCAD could be heading back towards 1.20.
Having gained more than 5% in Q1, the Japanese yen is on track to register a third consecutive year of gains against the USD. Economic reports released during the first quarter confirmed real GDP expanded 1.6% last year, double the Bank of Japan’s estimate for potential growth and the best performance in four years. Japan’s real exports also soared to an all-time high. The more recent leg of yen appreciation came courtesy of global risk aversion. Should financial markets regain their composure amidst an improving global economy, and GDP growth fall towards potential, the yen is likely to give back some of its recent gains and hence better reflect Japan-U.S. interest rate spreads.
This week was shaking for the cable. At the beginning of the week, the pound continued the Friday’s downward trend. However, it little changed ahead of the Bank of England’s meeting. Although the BOE kept interest rates unchanged at the level of 0.5%, hawkish sounding statements of the Governor made the pound rise. Mark Carney said that they are returning to targeting inflation at the two-year horizon. That is why they may raise the interest rate earlier than planned before. It caused the rally of the pound, and it could achieve the level of 1.4065 after the last close at 1.3875. However, the candle could not close at that height and fell to close at 1.3900.
The bullish trend of GBP could not fix because doubts about the Brexit deal still prevail. In addition, the significant plunge of the Dow Johns Index affected the pound as well.
The GBP/USD is moving in a horizontal trading channel between 1.3835 and 1.4000. They are support and resistance for the pair in a short-term. The next support is at 1.3741, resistance at 1.4070.