© Reuters. FILE PHOTO: US dollar banknotes are shown in this illustration taken on February 14, 2022. REUTERS/Dado Rovik/Illustration
by Harry Robertson
LONDON (Reuters) – If investors agree on one thing this year, it is that the dollar will fall. This has made the dollar’s 2% rebound over the past month particularly puzzling.
US inflation is falling and the Federal Reserve may stop raising interest rates next month. So the dollar must be on the way down, right?
Analysts say a number of factors may be at play. One is that a host of concerns — about US debt ceiling negotiations, the health of banks, and the global economic outlook — are polishing the dollar’s safe-haven credentials.
Meanwhile, there are some signs that the Fed may have to raise interest rates again, and more technical factors related to investor situation are involved.
Debt ceiling concerns
It — which measures the greenback against six others — has risen nearly 2% since mid-April to around 103, although it’s still down nearly 10% from last September’s 20-year high of 114.78.
The go-to explanation for currency strategists for now is that the debt ceiling crisis is strengthening the dollar.
Democrats and Republicans are close to reaching an agreement on increasing the $31.4 trillion borrowing limit. But the threat of a potentially catastrophic US debt default lingers at a time when many banks appear vulnerable.
When faced with such concerns, markets often buy less risky assets such as bonds, gold, and dollars.
“The recent strength of the US dollar is largely driven by increased safe-haven demand in light of the ‘unknown unknown,’” said Esther Reichelt, currency analyst at Commerzbank (ETR:).
“How severe are the vulnerabilities of US regional banks and what could be the implications of an escalation in the US debt ceiling conflict?”
Some worrying signs about global economic growth may also contribute to safe-haven buying. Data released from China this week showed that its economy was weak in April.
Feed may not be completed
Alvin Tan, Head of Asia FX Strategy at RBC Capital Markets, is skeptical of the safe haven argument.
If investors get worried, he said, stocks will drop. In fact, it has been flat since mid-April and is up more than 8% this year.
Part of the story, Tan said, is concerns that the Fed has yet to slay inflation. A University of Michigan poll last week showed consumer inflation expectations rose to a five-year high of 3.2% in May, sending bond yields and the dollar higher.
Traders currently expect the US central bank to cut interest rates sharply later this year as the recession drags on, but Tan is skeptical.
“We think there is an opportunity for higher US interest rates,” he said. “We still don’t buy the argument that the dollar is on the decline from here.”
natural recoil
For other analysts, the so-called technical factors come into play.
Investors placed big bets against the dollar. Net short bets by hedge funds and other speculators reached $14.56 billion last week, according to CFTC data, the largest such position since mid-2021.
Counterintuitively, this pose can help drive rallies. If the dollar rises even slightly, some traders may be forced to close out their short positions by buying the dollar, which boosts its value.
“The dollar is very oversold,” said Chester Netunifor, foreign exchange analyst at BCA Research.
“That’s one of the technical indicators. But a simple technical indicator is that it’s very unusual to have a straight line decline in the dollar.”