Deciphering the Dollar riddle

Perplexingly, Greenback has been on a roll this month despite the overall bearish profile for the currency. US sovereign bond yields are relatively latent and are going to remain low for considerable period given the Fed’s monetary policy stance. This has narrowed the spread between US 10yr yields and German Bunds and Japanese bonds to multi-month lows, rendering an unattractive US dollar. Fed recently announced to keep interest rates proximal to zero for at least three years, declaring to avert tightening until the economy attains optimal employment and 2% inflation on a sustainable basis. In fact, Fed made it amply loud that it will be in no hurry to raise rates, even if inflation temporarily violate its 2% target. Nevertheless, we take Fed’s approach with a pinch of salt given that the endeavor over the last ten years to attain long-term inflation has been futile and Fed’s favorite gauge of inflation PCE (Price Consumption Expenditure) index has barely exceeded 2%.

Apparently, it seems that the lack of progress on the US stimulus package has really bolstered the greenback. Although there is no doubt that US economy is recovering, we think markets are underestimating how long it will take for the process to play out and this would certainly involve yet more fiscal spending. We think that the momentum in the greenback will stall for sure, as focus will shift back to the desperate need for incremental fiscal stimulus from US Congress. In this regard, Fed Chair Jerome Powell told a Congressional panel that the path of recovery for US economy ahead remains uncertain and urged for additional budgetary support. Republicans and Democrats are trying to find a middle ground and seem to be getting closer to a deal.

We also have major reservations about Dollar strength ahead of US elections, wherein the bets on the next President of United States continue to see-saw. It is evidently a tight race between Trump and Biden and can go down to the wire. On the COVID situation, there is a clearly chance of second wave, manifested by resurfacing new infections in Europe. Onset of winter in the northern hemisphere can also make the epidemiological situation a more complicated one. In toto, a tense political backdrop, raging pandemic situation and a super accommodative monetary policy stance does not bode well for the currency. All these variables in aggregate support our bearish view and can exert downward pressure on the greenback against the basket of currencies in the weeks ahead. We see Dollar index retracing back to 92 levels.