Dollar View: Discipline or Stubbornness - BBH

"Although the dollar's pullback this year is more than we expected, regarding retracements, it is still quite modest," explains Marc Chandler, Global Head of Currency Strategy at BBH.

Key quotes:

"For example, using the euro peak of almost $1.40 in May 2014 and the low set at the start of this year near $1.0340, the single currency has almost met the 38.2% retracement at $1.1735.  The 50% retracement is found near $1.2170.   Sterling is nowhere close, but it has retraced 38.2% of the decline from the $1.50 high seen in June 2015 (which is found near $1.3055).  The 38.2% retracement of the slide from nearly $1.72 seen in July 2014 is almost $1.39. " 

"The yen as often is the case, marches to a beat of the slightly different drummer.  The dollar recorded a low near JPY99 in June 2016.  It rallied to JPY118.65 by the middle of last December.  The greenback's low for the year was set in April near JPY108, which is a little beyond a 50% retracement.  Last year's low was just beyond the 50% retracement of the entire Abenomics-sparked yen depreciation."  

"The Dollar Index retraced 38.2% of its rally from the 2014 low at  94.30.  It made a low yesterday of 93.64 but finished the North American session back above 94.00.  It ran into offers today at it approached 94.30.  The 50% retracement is near 91.35." 

"We suspect the market sentiment has swung too far in Europe's direction, having rebuffed the challenge by the populist-nationalists.  The eurozone continues to grow above trend, but the momentum appears to be stabilizing. Macron's election in France spurred several months of good feeling, but the honeymoon is over.  Macron's program of labor market flexibility, spending cuts and tax cuts for the wealthy will spur a push back, which is what prevented Macron's predecessors from succeeding with their reform agenda.  The top French general resigned over budget cuts, and Macron appears to have ruffled feathers by taking credit for developments in Libya that were initiated by Italy."    

"Similarly, we are concerned that investors may be too negative the US.   Market positioning, which had favored the dollar at the end of next year, now is heavily biased toward short dollar positions.  Neither the ISM, the Leading Economic Indicators, nor weekly jobless claims point to an imminent recession in the US.   It is true that political uncertainty and the unconventional US administration weighs on sentiment.  However, ultimately, we think monetary policy and the broader economy is more important.  It may simply require a greater interest rate premium to offset or compensate for this risk."  

"In conclusion, we identified the main economic driver of the dollar bull market as divergence, and we see it still being intact.  The dollar has depreciated, but it has barely met some minimum technical retracements that are common corrections in bull markets.  If these considerations change, we are prepared to reassess our outlook, but until they do, it seems premature to abandon our call. "