A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
Low Conviction Consolidation
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Andrew Kositkun Senior FX Advisor
The U.S. dollar index continues to trade in a consolidative manner after its sharp rally during the month of March. This pause in the dollar rally, due to a stabilization in U.S. rates, among other factors, has given room for other currencies, especially European ones, to reverse some of their March losses. Since the beginning of the month, the euro and the Swiss franc have outperformed commodity G-10 and high-yielding emerging market currencies, representing a flip of price action over a longer window.
On the positioning front, net short U.S. dollar positioning that was built up in 2020 and the start of 2021 has almost fully reversed. Euro long positioning has also decreased to its lowest level since June 2020, with yen positions turning net short from net long. Notably, there are some U.S. rate strategists who are starting to become more constructive on U.S. Treasuries, as they view the current market pricing for Fed hikes to be too aggressive. Should this view be true, declining U.S. yields would weigh on the dollar in the near term and remove one of the headwinds for emerging market currencies.
Given the dramatic change to consensus market narratives and the subsequent repricing of rates, central bank actions and reversals of currency positions, investors are taking a wait-and-see approach in the near term. In essence, the market needs more positive catalysts to increase its conviction and engagement. One key potential catalyst is President Biden’s infrastructure bill. Because funding of this bill is dependent on tax hikes, more clarity will be needed, as higher taxes face opposition not only from Republicans, but also from moderate Democrats. This uncertainty then leads to a low conviction environment that leaves markets a bit directionless and flow-driven; such an environment isn’t conducive to taking definitive positions. As such, European currencies have been able to outperform despite eroding fundamentals.
While the U.S. dollar may be taking a breather in the near term, the medium-term view remains unchanged. Europe continues to suffer from a sluggish recovery, underperformance on vaccination distribution, a recent surge in the virus and, above all else, low trend growth. New COVID-19 cases are most notable in Germany, France, Italy and the Netherlands, with new infections per million in Germany surpassing the rate in the U.S. This nets out to a continued tightening of restrictions in Europe, with economic data already showing a resulting drag on the economy. In contrast, the U.S. and U.K. are easing restrictions, and this dynamic of divergent virus backdrops should continue to weigh on the euro.
Beyond the virus, economic data should also receive additional focus amid a low conviction market. Key releases include today’s U.S. March consumer price index, which rose 2.6% year over year against consensus for a 2.5% increase. Today’s print was the biggest increase since 2012. Core prices also rose faster than anticipated, at 1.6% year over year versus expectations for a 1.5% increase. Additionally, U.S. retail sales (Thursday) and China’s first quarter gross domestic product (Friday) will be in focus and should confirm the U.S. and China’s outperformance versus the rest of the world.
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