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Trader: Why Dollar’s Surprise-Driven Rally Could Soon Consume Itself

Courtesy of ZeroHedge. View original post here.

By Garfield Reynolds, macro commentators and a Markets Live blogger for Bloomberg.

Dollar’s Surprise-Driven Rally Could Consume Itself: Macro View

The astonishing thing about the recent rally in the greenback is how surprised so many have been by its strength at a time when the U.S. economy has been an oasis of resilience amid a desert of dismal global data. But the U.S. currency could soon face headwinds as expectations elsewhere shift and its very strength could spark a reversal with many drivers for dollar weakness still very much in play.

The dollar’s rally makes a world of sense if you look at relative economic surprise data. While U.S. figures have continued to exceed expectations since the end of February, those for Europe and Japan have crashed to multi-year lows.

The euro and the yen account for more than half of all FX transactions, so it’s no wonder the greenback has been so perky of late, rising about 1 percent against the former this month and over 2 percent against the latter. In addition, both heavyweights tend to drag along major satellite currencies with them — the British pound, Swiss franc and Scandies for the euro, a bag of Asian currencies led by the Korean won for the yen.

Part of the impetus for the strong gains from EUR and JPY in 1Q was the perception that improving economies there meant central banks were moving toward exits from massive stimulus. However, deteriorating economic data as well as domestic scandals engulfing the government in Japan have seen those expectations dialed back, easing pressure on the U.S. currency.

Meanwhile, rising Treasury yields are beginning to have an effect, the 10-year is at a 4-year highs, increasing the attractiveness of dollar assets.

Still, the concern for dollar bulls is that many of the other drivers for USD weakness remain in play, and may even be exacerbated by the latest rally.

  • The twin deficits have suddenly vanished from the radar, even though higher interest rates are going to expand the fiscal shortfall and a higher USD can widen the current-account gap if it reduces export competitiveness.
  • Inflation will also struggle to sustain its rise in the face of a stronger USD, especially as the alleged commodities boost to consumer prices has been underpinned by idiosyncratic factors — Syria, the Saudis desire for high crude prices as they prepare for the Aramco IPO, sanctions on aluminium.
  • The aforementioned U.S. surprise index may reverse course, while the European and Japanese gauges could rebound now that economists have downgraded their expectations.
  • Oh, and of course a strong dollar tends to provoke tweetstorms from the White House.

So while the current economic picture argues for this burst of USD strength to extend for a while – especially if it squeezes out some of those near-record shorts - it may struggle should the currency get back above its November highs.


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