Dollar's Desert Exile Will End Soon

bilal hafeezDollar’s desert exile soon to end, but for many market participants, there appears no end to dollar disappointment.

Bilal Hafeez at Deutsche Bank sums up his bank's latest research on the US dollar and why they believe strength will return soon.

For James Malcolm, this is the best reason yet to hope for a turnaround.

He argues that the structural legacy long in dollars has washed out, and the macro hedge fund community has all but given up. Yet near term catalysts are present in the form of warmer weather helping US data, continuing China slowdown and potentially aggressive policy responses from other G3 central banks.

There is some evidence for this view. The IMM shows dollar longs have fallen for 8 consecutive weeks, a trend that hardly seems like reversing when the CFTC release the latest data later today.

The news-flow from China over the last 48 hours will disappoint those hoping for stimulus, and recently announced capital account measures may increase renminbi volatility, which won’t be good for commodity-orientated EM. However, an as yet absent data acceleration will be the necessary condition for strength against majors.

Of course, one of the most important reasons for USD weakness has been capital flows. Previously, it was assumed that weak fixed income inflows were one of the main drags on dollar performance.

In an enlightening FX Daily, Alan Ruskin shows this to be wrong.

Due to design flaws, TIC data has massively underestimated foreign purchases of treasuries and corporate bonds (to the tune USD 400bn over 2013 in the former case), meaning the burden of explanation for dollar weakness lies on US purchases of foreign equities and bonds.

As we have previously argued, these flows have been the most correlated to USD in the bop.

What next? Much hinges on the US flow story and Ruskin’s analysis provides two meaningful insights.

First, the higher US yields-stronger foreign appetite for US bonds relationship has not in fact broken down and further rate rises should encourage yet more foreign purchases.

Second, the key turning point will be when US investors turn away from foreign assets.

As noted last week, foreign appetite for Eurozone equities may have already reached saturation point.