The dollar’s post-US election surge has investors contemplating not whether they have overdone the rally but just how far the greenback can rise and how quickly it will get there.
A series of currency landmarks, which not long ago investors thought too distant to worry about, have already been trampled by the dollar’s relentless march. The euro fell below $1.06, the yen weakened towards ¥111 against the dollar and the offshore renminbi fell below Rmb6.90.
The 100 level in the dollar index, which measures the reserve currency against a basket of its peers, was reached at such speed that the 101 level was soon surpassed by Friday.
As Brad Bechtel at Jefferies International said: “The party rages on but the question remains, when will it end?”
Not for a long stretch, according to Ulrich Leuchtmann at Commerzbank. With the Federal Reserve poised to normalise rates, and inflation expectations intensifying on the back of likely tax cuts and fiscal stimulus from the new US administration, he is forecasting a 4 per cent rise in the dollar index by the end of 2017 and a 7.5 per cent rise 12 months later.
Hurdles that may have tripped up the dollar are being overcome with ease. Fed chair Janet Yellen did not stand in the way, declaring last week a rate rise might be appropriate “relatively soon”.
The expectation of a December policy tightening and more to come in 2017 shapes as one of the big drivers of dollar strength, as is the rise of the populist right, which is putting pressure on the euro.
Another target in analysts’ sights is euro-dollar parity. For 18 months, the euro has been in a range of $1.07 to $1.15, said Bilal Hafeez, Nomura FX strategist, but attempts to break the bottom of this range have been foiled by falls in German equities, a shift in rate differentials and sharp reversals in hedge fund positions.
These factors that have cushioned the euro are under strain as Europe grabs investors’ attention in the coming weeks, including the Italian constitutional referendum, the French primaries for the centre-right presidential candidate and a European Central Bank meeting.
Mr Hafeez said: “The risk aversion/euro correlation is not as stable as before, the US yield advantage is now sufficient enough to maintain a euro downtrend, even if it were to moderately reverse, and positioning is less of an issue. A move below parity is certainly possible.”
Other analysts have hastily revised forecasts across a raft of currencies, not least the renminbi. Describing current market sentiment, Mr Bechtel said the dollar was “on a one-way train higher” against the Chinese currency.
The renminbi fell to eight-year lows on Thursday and Friday, raising questions about the likely response from the People’s Bank of China to further falls as it worries about the rising dollar’s affect on capital outflows.
Simon Derrick, macro-strategist at BNY Mellon, said it was notable that the $45.7bn fall in China’s reserves in October took place against a “relatively benign FX environment”, making the extent of PBoC intervention to offset the post-election dollar rally a pressing issue.
“The debate over what China is likely to do next with regard to currency policy and how this will impact domestic and international markets will attract more interest in the weeks ahead,” said Mr Derrick.
MUFG said it was raising its renminbi forecast to Rmb7.00 in the first quarter of 2017. One important consideration is whether president-elect Donald Trump ups his rhetoric on China as a currency manipulator, even if the renminbi’s latest falls are being driven by dollar strength.
“If he goes hard in on China we could see the currency considerably higher than [Rmb7.00],” said Derek Halpenny, FX strategist at MUFG. But he added that it was unlikely the PBoC would allow the renminbi to fall too far.
“What fuels capital outflows has been expectations of the currency’s direction, as well as growth in China. I don’t think they would want to create a scenario that would intensify those expectations.”
