- Technicals support weaker dollar
- Fundamental data surprises causing dollar to swing
- Monetary and fiscal stimulus to continue
- U.S. facing record high double deficit
USD index DXY has been volatile at the back of a number of data points published in the U.S. DXY, weighted 57% against EUR, has shed -2.83% since March 31st high of 93.44 to current 90.35.
The Greenback had been in a bullish trend since early 2021 and seemed to be heading higher, only to reverse the course when President Biden published his US$ 2.25 trillion American Jobs Plan on March 31st. The dollar has been sliding since and slumped 67 bps further after a failed attempt to consolidate in early May near 91.30 when a disappointing jobs report was published last Friday. Support level formed at the lower Bollinger band near 91.15.
CPI data surprise earlier this week pushed the dollar up 61 bps to 8-day exponential moving average, but price failed to find momentum to the upside. Furthermore, weak retail sales data published today has sent DXY lower once again, currently near 90.35. Momentum indicators are bearishly stacked on both the daily and weekly chart, indicating that further downward move is likely, and the dollar might retest swing lows near 89.50 again these coming weeks.
Fundamentals seem to support a weaker dollar – the federal government has poured more than US$ 5 trillion of stimulus to the economy since the start of COVID-19 outbreak last year, with another US$ 1.3 trillion to be raised during Q2 and Q3 this year. This number is not inclusive of the latest American Jobs Plan and American Families Plan that sum up to US$ 4.5 trillion.
The American Jobs Plan is unlikely to be passed in the Congress in its current shape and form as we expect a watered-down bill probable to find support among Republicans and moderate Democrats. American Families Plan, on the other hand, is likely to be passed using budget reconciliation process that doesn’t need Republican votes but can only be implemented during fiscal year 2022 that starts in October 2021.
This aggregate amount of spending sends federal debt to near the WWII record highs of 108% of GDP, and government deficit in fiscal year 2021 to US$ 2 trillion, as per the estimate from Congressional Budget Office (CBO).
On top of fiscal spending, the Fed continues its monetary largesse. In addition to the US$ 2 trillion temporary qualitative easing programs introduced in March 2020, the Fed is still buying US$ 120 billion worth of mortgage-backed securities and Treasury bonds every month. Chairman Powell and other Fed officials echo the same message – monetary support will remain in place until there is significant improvement in the labor market and average inflation reaches 2%.
Whilst CPI pop of 4.2% in April may move us closer to the Fed’s target, disappointing jobs data published last week means the Fed is unlikely to change current monetary policy. In fact, the Fed rarely embarks on a policy tightening cycle without labor market recovery. Current 6.1% unemployment rate and a pool of 10 million available labor means it will take us around 3 years to recoup the lost jobs, assuming the same trend continues.
Increasing fiscal deficit is one side of the story – the U.S. is also facing a growing current account deficit, rising mostly from trade deficit. Direct cheques sent to individuals have resulted in a retail spending rally in Q1 this year when nominal level exceeded pre-pandemic levels. However, there has inevitably been leakage to foreign GDP as Americans have turned to e-commerce. Imports grew 6.3% in March to a record of US$ 274 billion, whilst exports were up 6.6%. Deficit itself grew by 5.6% to US$ 74 billion, the largest contribution of US$ 36.9 billion coming from China.
Double deficits inevitably mean that the U.S. needs to issue more dollars which is done through debt issuance and raising taxes. Despite being the reserve currency, at some point the trust in the dollar and in the creditworthiness of the U.S. federal government is likely to erode. Investors, including other sovereigns, have increasingly been dumping U.S. Treasury bonds at the back of inflation scare, pushing 10-year yield up to 1.65% at the time of writing this article. Whether the relatively high growth of the U.S. economy lures investors back is yet to be seen. For now, the bearish case for the dollar seems to be building up.
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