Market analysis: dip for the dollar after record run

With the recent run of anaemic numbers – it is almost impossible for a rate hike to materialise in the summer months, writes Gaurav Kashyap.

The Dollar Index, a measure of the value of the dollar against a basket of major currencies, slid 3.67 per cent on the month. SeongJoon Cho / Bloomberg

The US dollar closed its worst month in four years – ending a record run of nine consecutive months of higher closings dating back to July 2014.

The Dollar Index, a measure of the value of the dollar against a basket of major currencies, slid 3.67 per cent on the month as a rebalancing coupled with a sharp unwinding because a weaker than expected US data docket exacerbated fears of a US economic slowdown.

As we had mentioned last month, it was only natural that a correction would result on the back of profit-taking – however, a key run of US data kept risk appetite in check and this stoked expectations of a delayed interest rate hike from the Fed.

April’s numbers were dismal from the US – as expected, the dollar sell-off started with a far weaker than expected April US nonfarm payrolls reading of 126,000 versus expectation of 245,000. The downwards moves were intensified as the weak economic docket continued across the board, with US industrial production dropping to -0.6 per cent versus expectation of -0.3 per cent and consumer confidence fell to 95.2 versus expectation of 102.5.

But perhaps the biggest let-down was the US GDP first quarter reading which came in at 0.2 per cent, down from 2.2 per cent from the fourth quarter of 2014 on the back of a weaker personal consumption number – 1.9 per cent versus 4.4 per cent previously.

Following the release of the US GDP, the Federal open market committee decision to keep the rate unchanged at 0.25 per cent and the subsequent hawkish press conference helped to pare some of the earlier losses in the dollar.

From its statement, the Fed clearly sees the slowdown in data as a result of “transitory factors”, that is, the weather and fully remains on course for a 2015 rate hike – whether the US capital markets are ready for it or not.

With the recent run of anaemic numbers – it is almost impossible for a rate hike to materialise in the summer months with the fourth quarter a more likely time frame. But the Fed did provide reassurances that any upcoming risks to future outlooks were balanced, and this helped a slight dollar recovery.

Last year, after a weaker first quarter, we saw a strong recovery in the numbers during the later quarters – and this may prove to be the case in 2015, as the Fed believes.

This month’s upcoming numbers will be key in dictating that market sentiment, starting with this Friday’s US nonfarm payrolls (225,000 expected/126,000 previous). We expect the “transitory factors” to continue to have a lag through this month’s US economic calendar, and this should continue to weigh down the dollar in the weeks ahead. The lower target of 94.20 given last month held up and will continue to be a key support level for the US Dollar Index followed by 93.50 levels.

Across the Atlantic, the euro bounced sharply from 12-year lows, snapping a nine-month losing streak. The currency was up more than 4.5 per cent last month, stabilising comfortably above our first channel at 1.12.

While a lot of the upwards momentum can be attributed to the recent dollar weakness, the improving sentiment out of Greece has also helped risk appetite. Greece is due to make a €200 million payment to the IMF this week and is fully expected to be provided the necessary liquidity by the European Central Bank to do so.

Of course we expect political posturing between the ECB and the Greek prime minister Alexis Tsipras to lead to heightened levels of volatility through the deadline ECB governing council meeting tomorrow. Barring a highly unlikely outcome, we expect the euro-dollar to trade sideways in the channel between 1.10 and 1.15 in the month ahead.

And finally, all eyes will be on the exit polls in the lead-up to this Thursday’s UK vote. After a strong month of gains (as a result of the weaker dollar), sterling will find range-bound movement as markets await the outcome of one of the most closely contested elections in UK history.

We expect volatility to pick up following the election results – despite the prime minister David Cameron’s EU referendum promise, the incumbent Conservative-Liberal democrat coalition (which is traditionally considered positive for the UK economy) would improve the outlook for the sterling against the greenback in the weeks ahead with a move towards the channel between 1.55-1.57 on the cards. A Labour-led coalition, on the other hand, would weigh down pound-dollar forecasts with a move towards the channel between 1.46-1.48 likely.

Gaurav Kashyap is a foreign exchange expert based in Dubai