US dollar primed for a comeback

Many of the themes discussed in my last article in November continued through the start of December. Anti-dollar flows led to further downsides in the greenback as major currencies such as the euro, British pound, Canadian dollar and Australian dollar tested multi-month highs against the US dollar. While my initial support levels in the Dollar Index at 92 were easily compromised last week when the index hit a low of 90.48, recent pricing suggests we have found a bottom in this current channel. Increased short covering will see more balanced, two-way pricing coming into the greenback, giving it some support for a move higher as we enter the last few weeks of 2020. Other than inflation data, there is not much on the US economic calendar this week and attention will turn to next week’s Federal Open Market Committee statement. The inflation print will have little guidance on upcoming Fed policy, and while we aren’t expecting any major fireworks from the US central bank on December 16, I would pay close attention to the language in their statement. Since June, the Federal Reserve has been picking up around $80 billion a week in Treasury bonds – annualised, that works out to additional liquidity of approximately 20 per cent of total US gross domestic product in 2020 – and a lot of this liquidity has fuelled the rise in US equity markets. But, with an economy that’s potentially on the mend, the Fed hinted in its last meeting minutes in November that “while participants judged that immediate adjustments to the pace and composition of asset purchases were not necessary, they recognised that circumstances could shift to warrant such adjustments”. Any expansion or further fortification of this language would have a negative impact on US equities and a positive impact on the US dollar. To reiterate, future Fed action will ultimately come down to two factors: the US data docket and the ongoing Covid-19 developments in the US. The US data docket has been uneven to say the least. Third quarter GDP bounced back to grow at 33.1 per cent while both manufacturing and non-manufacturing purchasing managers’ indexes were firmly in expansionary territory. However, a weaker jobs report (November payrolls came in at 245,000 versus an expected 469,000) and slower retail sales have kept optimists of an economic recovery largely in check. To add to this, new record Covid-19 cases in the US will keep a check on markets and maintain the Fed on its current asset purchase path. US equities have been on an absolute tear of late – after smashing through 30,000 and hitting record highs last week, the Dow Jones Industrial Average came in for a correction to start this week – and if we see a deeper sell-off through the next few weeks of December, this will be positive for the dollar. Across the pond, all eyes are on Europe this week, with the ongoing Brexit talks, the European Central Bank rate decision due on Thursday and the European Union summit to end the week. After fulfilling my upside target of 1.35 last week, GBP/USD has been under pressure this week following the ongoing Brexit turmoil. Expect volatility to remain elevated in GBP crosses in the weeks ahead. The ECB announces rates and its monetary policy tomorrow. While no changes in rates are expected, the ECB has made its intentions very clear over the past few months. Troubled by a bumpier recovery for the eurozone, additional coronavirus restrictions that may likely continue through the first quarter of 2021 and the risk of a double-dip recession, expect the central bank to announce additional easing measures in its monetary policy statement, and leaving the door open for additional measures in the near future. This should potentially impose a cap on any further EUR/USD upside moves in the near future. Following the test of those multi-year highs over the past few days, 1.2550 remains a medium-term resistance level in EUR/USD, with short-term resistance now coming in at 1.22 levels. Following ECB’s action today, I expect the pair to re-test the 1.1950/1.20 level in the next two weeks. Finally, gold dropped 5.4 per cent in November, sparked by a mass exodus of December gold option expiries. After bottoming out in the channel between $1,760 and $1,780, the precious metal has staged an impressive recovery in December and looks good to test $1,900 levels in the next two weeks. Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti