Against a basket of international currencies the USD has reached its highest levels so far this year powered by positive economic data and hopes of early interest rate rises. But for the time being at least the rally is starting to look over-stretched.
That's not to say the USD rally is necessarily over, it's just that a big slice of the gains were made quickly over the course of just one month – July. That suggests USD is probably due for a pause.
Meanwhile, the US Federal Reserve is on course to end its quantitative easing programme in October, which will be a key moment for forex markets and the world economy. It could be another reason to buy USD, but not just because of anticipated US interest rate rises and a normalised economy.
EUR/USD – looking ready for a pause in the rally
The stock market looks over-stretched
Quantitative easing has helped fuel an enormous global stock market rally. The S&P 500 index started rising from around 680 in March 2009 and now stands at around 1,920. That's a five-year rally, which is definitely looking long in the tooth.
Some of the rally is due to saving the financial system and improvements in company balance sheets, but a certain amount is also down to tidal waves of easy money and the taps are soon to be turned off. Real estate markets around the world have similarly benefited. At the moment the end of US QE doesn't appear to be priced into the stock market and the timing of its ending is also ominous, October. A month often associated with stock market crashes.
Indeed, if equity markets do start to sell-off aggressively investors will rush towards safe havens such as USD and US Treasuries. The risk-off trade will be back in vogue. And there are a lot of factors, which could upset the stock market, such as the situation in the Ukraine, the usual Middle East tensions and the sabre rattling going on between China and some of its neighbours.
However, if the US and other major economies are growing sustainably, then the stock market and risk currencies should recover fairly swiftly. But at the moment USD still looks a good trade, particularly if it can pause for a breather before moving up again.
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