July 1, 2018,   12:04 PM

Relentless Buying Momentum For USD Bodes Well For Pegged Currencies

Jameel Ahmad


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The stunning transformation in investor sentiment towards buying the Dollar over the second quarter of 2018 has enforced relentless pressure on its global counterparts as we enter the second half of the year. It also does not appear that the trend of buying the Dollar is about to conclude any time soon, with reports circulating on June 25 that hedge funds have loaded up on buying Dollar positions at the fastest pace on record. This change in sentiment has played a leading role in the Dollar Index peaking above 95 for the first time since November 2017, with the Dollar overall trading at its strongest level since July 2017.

It would be an understatement to suggest that there have only been a few victims in the global markets from the Dollar rally.  A wide variety of different instruments across the globe are feeling the heat from the advancement in the Dollar, including both commodities and a wide range of different emerging market currencies. Gold has lost nearly 7% in its value over the past three months and has declined nearly $50 in less than two weeks. The losses have been even more excessive for emerging market currencies on the other hand, with the South African Rand weakening an astounding 13% during the second quarter. As of June 27, there are only two emerging market currencies across the globe to have gained against the Dollar this year. These are the Colombian Peso and Malaysian Ringgit. This ultimately means that currencies pegged to the Dollar have enjoyed a lot of strength against emerging market counterparts in recent months.

Developed currencies have also suffered against the Dollar during this period. The Euro has weakened to its lowest level since last summer with losses just over 5.5% this quarter. The British Pound has declined close to 6% during the same period, while the Swedish Krona has lost over 6.5%.  The Australian Dollar has declined by just over 4%, but the outlook of the Australian Dollar is at risk of further deterioration over the second half of the year, as a result of the trade war concerns between China and the United States. Australia is well-known to investors as a major trading partner of China and its economy is seen as being at threat to an unforeseen slowdown if a trade war does break out between two of the largest economies in the world.

While the list of instruments losing momentum against the USD over the previous quarter might appear daunting on the eye, there have been some winners from the Dollar drive across financial markets. This includes those currencies pegged to the USD such as the UAE Dirham, Saudi Riyal and Lebanese Pound, that have mirrored the Dollar strength against its counterparts. Each of these pegged currencies for example are trading at their strongest level against the Euro in over six months. They will also have noticed that they have advanced significantly against the South African Rand over the past three months.

What is potentially most encouraging for pegged currencies heading into the second half of 2018, is that the outlook from most is that the Dollar rally should have the legs to extend even further. Investors are concerned over indications of another economic slowdown in the developed markets, with EU economic data not managing to compete with the outperformance of last year and two years on from the historic EU referendum, Brexit remains as much of a mystery as ever. There are even concerns that Brexit uncertainty is the driving factor behind the UK economy showing the weakest growth expectations of the developed markets. Meanwhile the US economy is continuing by most accounts to fire on all cylinders, which is constantly reminding investors that the distance in consistent economic growth between the United States and its developed peers is forever stretching wider.

The contrast in economic growth between the United States and its developed peers is not the only reason why investors remain positive on the Greenback. Interest rate differentials between the US Federal Reserve and its counterparts is another factor that is luring investors towards the USD. The European Central Bank (ECB) hinted earlier in June that they do not think EU interest rates will be increased until at least the second half of 2019, whereas the Federal Reserve could attempt to raise US interest rates another 4 – 5 times during this period. This would mean that US interest rates could stand at close to 3%, before the ECB is in a position to raise interest rates away from their current record-low levels.

One factor that all investors will need to monitor moving forward is how the trade war fears are impacting global market sentiment. There is an expectation that due to the trade war threats coming from President Trump himself, that the US economy will be better-equipped to handle the headwinds the global economy might face in comparison to those economies Trump is targeting with trade tariffs.

There is even speculation that if a trade war does erupt, investors will seek the Dollar as the world’s reserve currency.

Jameel Ahmad is the Global Head of Currency Strategy & Market Research at FXTM

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