Dollar stabilizes after four days slide

The greenback’s sell-off paused early Tuesday after touching its weakest level since January 2015. Traders have been selling the buck across the board since Monday even though U.S. markets were closed for Martin Luther King Day. This suggests that growing optimism about global economic growth will sooner than later force major central banks to unwind their easy monetary policies.

Apparently, it's not the U.S. data driving the dollar. If this was the case, last week’s core CPI and retail sales figures should have supported the currency. In fact, traders have become aggressive sellers of the dollar with short positions, reaching $9.2 billion a week ago according to Commodity Futures Trading Commission's weekly Commitments of Traders (COT). Given that sentiments have become the key driver of FX flows, the downtrend in the U.S. dollar may continue in the short run.

The question that may come to traders’ minds, is how much further will policymakers allow their currency exchanges to appreciate against the dollar? Earlier today Japanese Finance Minister Taro Aso commented that he did not see problems with the USDJPY hovering around 110.80 yen. However, he admitted that big swings in currencies would be problematic. Yesterday’s Eurozone trade balance showed that despite the strong Euro, trade surplus rose to its highest levels in eight months, suggesting that the stronger Euro, isn’t becoming a headache to European companies yet.

Comments from ECB’s governing council member Adro Hansson yesterday, suggested that the bond-buying program could end entirely in September, if the data warranted. So, I believe inflation figures in the next three months will be a key metric to determine whether the ECB will put an end to stimulus.

Sterling, which also benefited from the bearish sentiment surrounding the dollar, climbed above 1.38 for the first time since the Brexit vote. Progress on Brexit negotiations have been a significant driver for the pound, but given that we’re still in the early stages of the second round of talks, expect to see some volatility in the pound. Focus today will turn to U.K. data, particularly the CPI release. We expect that inflation will have fallen by 0.1% in December from 3.1% in November. However, a fall of more than 0.2% will likely lead to some profit taking in GBPUSD.