One way of grasping the latest tumble in the US dollar is to think of the following:
As expectations of a 2015 Fed hike grew increasingly cemented in the market, traders demanded a higher bar of positive US data performance, especially as macro-normalisation in Europe transitioned into outright progress. Not only most US figures failed to show a sufficient upside surprise since end of April, but business surveys and inflation data from Europe revealed evidence of progress from the ECB's QE program.
In Jan-Mar, the greenback soared to decade highs against most currencies on the possibility that the Fed would raise interest rates in 2015. In yesterday's FOMC announcement, the USD sold off due to bigger than expected downgrade in 2015 GDP growth (revised to 1.8-2.0% from 2.3-2.7% in March), as well as lack of clarity with regards to the pace of future Fed hikes.
Although 15 of 17 FOMC officials expect lift-off to begin this year, FX markets require a faster pace of subsequent rate hikes in order for the US dollar to regain the momentum it once had when the possibility of a 2015 rate hike were sufficient for the rally.
The US dollar rally has now reached critical levels on both fundamental and technical grounds.
Fundamentally:
- Bank of England will likely have at least two hawks dissenting against the monetary policy status quo by end of summer due to persistent improvement in jobs and earnings figures, as well as anticipated rise in inflation data.
- Increased probability that Eurozone CPI will overshoot the ECB's 0.3% y/y projection, with 0.8%-0.9% as the more likely year-end figure -- should sway the German-US yield spread further near positive levels from the current -152 bps.
- Increased resistance inside the Bank of Japan's policy board over stepping up monthly further asset purchases will stand in the way of further yen weakness, especially if US and European bourses are rattled by the simultaneous threat of disappointing US earnings season and persistent chatter of 2015 Fed lift-off.
Technically, the ensuing Death Cross formation in the US dollar index, and Golden Cross in EURUSD (occurring when key measures of short-term trend exceed longer-term trends) is taking place for the first time since almost exactly 365 days. The developments are backed by important resistance levels in GBPUSD and EURUSD, while USDJPY tests key 122.30 support foundation.
