USD index is peaking out, but USD/JPY to hold firm – Deutsche Bank

The upward cycle in the USD index is peaking after nearly six years as the downturn in the currency was sparked by the rebound in European and Canadian currencies in line with the strengthening economic sentiment in those regions, explains Taisuke Tanaka, Strategist at Deutsche Bank.

Key Quotes

“The backlash from the Trump rally of last year-end has also heightened this decline.”

“The falloff in the dollar has lightened the capital outflow from China and other emerging economies. The easing in market concerns on China’s hard-landing risk has improved the outlook for Asia overall. The turnaround in prospects for demand in Europe and Asia and drop in the USD index has buoyed commodity markets. This has spurred a recovery in currencies in resource-producing nations and emerging markets, which has also contributed to the further drop in the USD index.”

“That said, we do not anticipate a dramatic slide in the USD index. The US economy itself remains solid. Hopes of fiscal stimulus measures in the US have faded this past half year while consumer confidence has failed to take off, leaving prices inert, interest rates soft and the dollar in retreat. Nevertheless, if growth continues at a pace of over 2% under virtually full employment, we would expect prices eventually to creep higher and the Fed to move forward with multiple rate hikes.”

“Once the robustness of the US economy is reaffirmed and the dollar bounces back, we believe the currencies of Europe, resource nations and emerging markets to slip in varying degrees. The yen should also fall against the dollar. If a weak dollar phase is due to risk-on conditions in Europe, resource nations, emerging economies and the world as a whole, we believe the yen would decline on an effective exchange basis.”

“Broadly speaking, the USD index and the USD/JPY have historically been well correlated. However, they do not always move similarly over the short or medium term, and the turning point in their trends does not always coincide. We believe the peaking in the USD index will be erratic and slow given the ongoing firmness in the US economy and the gradual rise in interest rates. We expect the yen to remain bearish against the dollar without synchronizing bullish euro or other major currencies.”