Dollar’s drivers turning negative

A few weeks ago, every piece of macroeconomic data, every global event and even every comment from a politician or Central Banker seemed to have a positive effect on the value of the greenback and this pushed the dollar index to new highs not seen since June last year.

Now we are seeing sentiment start to reverse, so where Trump’s bashing of Turkey saw the dollar rally, the involvement of Qatar and therefore Iran has become a negative with potential for further unrest in the Middle East. The data releases haven’t been quite as strong as they were, and the Fed has been forced onto the defensive by the President’s comment that he is “not thrilled” by the continuing pattern of rate hikes.

Of these, now negative, drivers, it is a continuing conflict between the Central Bank and the Administration that is potentially the most damaging. Whilst it is no doubt true that Jerome Powell, the Chairman of the Federal Reserve, has proven to be more hawkish than markets (and presumably the President) had expected, any interference in the workings of the Central Bank or its independence will create doubts in the market. These will send the dollar appreciably lower since the recent strength has been built on a continued and widening interest rate differential.

Yesterday the dollar index continued its recent fall extending losses into a fourth consecutive day. It reached 95.25 and now sits right on a strong support level.

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Sterling has nowhere to go in the short term

A summer which has seen endless conjecture regarding the type of Brexit the UK can extract from Brussels is coming to an end without any official comment from either side. The most damaging remarks came from Bank of England Governor, Mark Carney.

His comments on a hard or no-deal Brexit were prefaced by his saying that it was not his base case that no deal would be reached. However, in good old market tradition, if a Central Banker voices an opinion, the market reacts.

The fact that Carney voted, along with all his colleagues on the MPC, for a rate hike recently should have been taken as a sign that he is confident that a deal can be struck. Many traders see the hike as simply providing a platform for a cut if the “going gets tough” during the coming months. It is notable that hedge funds have stayed on the sidelines awaiting a clearer signal of the currency’s direction, having been badly burned over speculation of a hike earlier in the summer, which failed to materialize. If that sector joins any selling on further hard Brexit speculation, then the low 1.20’s versus the dollar become a real possibility.

Yesterday, the pound rallied against a weaker dollar and was virtually unchanged against the euro reaching 1.2926 and 1.1151 respectively.

Concerns over Turkey driving euro

Even though as far as much of the market is concerned the “Turkish crisis” is now controlled, there are two continuing issues that are holding back the single currency. The first is Donald Trump and his uncanny ability to conjure a crisis out of thin air, although in this case, he has the makings of a drama to work with.

The second is the level of involvement of Eurozone banks in Turkey and the ability of Turkish corporate accounts to pay back euro borrowings even though the currency has stabilized.

Contagion is a word, like stagflation and parity, that is rarely uttered in markets, and is seen even less. During the financial crisis, it was contagion, the inability to stop the crisis spreading from Eurozone member to member, that wrought major issues. Whilst the lesson has largely been learned, the fact that if one financial institution sees an opportunity, they all will, has led to concerns about overreaching. Should Turkey appear to distance itself further from Europe and more importantly NATO, this could drive a major crisis of confidence.

As the dollar weakened yesterday, the euro managed to reach a high, almost against traders’ better judgement, of 1.1602 but there is a real sense that further weakness beckons.