FX Monthly Outlook: Dollar remains strong as central banks ease

Last month the dollar index reached its highest level in over two years.1 Its persistent strength has defied market strategists (including myself) who have forecasted a material downturn within the year. The downturn has not materialized leading many currency analysts to call the strong dollar one of the big “missed market calls” of the year.

Notwithstanding what analysts thought, global investors got it right, remaining long on the dollar and US assets, especially tech stocks and US Treasuries.2 In addition to relatively attractive yields and returns available from investing in US assets, there has been significant safe-haven demand for the dollar, as relentless geopolitical uncertainties and tensions both here and abroad continue to foment uncertainty.

What happened

Big central banks eased monetary policies.

  • Prominent central banks eased monetary policies. Last month the Fed, the Bank of England, the European Central Bank, the Bank of Canada, and the Bank of Japan eased monetary policies and set the stage for a return to Quantitative Easing (QE). The moves were anticipated given persistent slow global growth, ongoing trade tensions and low inflation rates.3 Central bank members and market pundits argue that lowering already low interest rates could lessen the effectiveness of the practice. ECB president Mario Draghi encouraged Germany and the Netherlands to consider increased fiscal spending as much-needed stimulus to slow the economic down-turn. 4
  • Euro fell to 2 ½ year lows. Following a contraction of the Eurozone Manufacturing PMI (an indicator of economic trends in the manufacturing and service sectors) the German industrial sector declined into recession, which led to the overly-dovish ECB meeting. By the end of September, the euro traded under $1.09, ending the month as one of the world’s worst performing currencies. 5

Oil prices spiked. Oil prices jumped nearly 20% after drone attacks on Saudi Arabia infrastructure destroyed more than half the nation’s production capacity.6 The price jump marked the largest percentage daily gain in nearly thirty years and triggered knee-jerk rallies in the dollar, yen, US Treasuries and gold as investors flee to safe haven assets. 7

Mexican peso takes place as a top performer. The Mexican government announced a ‘realistic but conservative’ 2020 budget with an economic growth target of 2%, and material increase in social spending.8 Despite analysts concerns that the country’s growth assumptions are overly optimistic, the Mexican peso gained and was a top-performing currency for the month. 9

What’s at Play

Nancy Pelosi announces formal impeachment inquiry. Within 24 hours of the announcement, markets responded with rallies in the S&P up 0.70% (risk-on), 10-year T-bonds yields up 10 bps (risk-on), and dollar index up 0.70% (risk-off). 10

Italy forms a new government—again. Since WWII, and the reign of Mussolini, Italy has (by design) built a government that modulates presidential power.11 The latest changes mark the 67th government structure for the country. Even so, the euro was unmoved by the change, and Italian bonds remain in demand (for their yield), with the Italian stock market outperforming most other EU countries in September.12

Spain coalition-talks collapse. Caretaker Prime Minister Pedro Sanchez failed to gain the support of the left-wing Podemes and pro-market Ciudadanos parties, setting the country on course for an election on November 10 – its fourth in four years.13 The euro was unaffected by the news, Spanish government bonds are in demand, and Spain’s stock market has outperformed most other EU countries for the month. 14

Protests continue in Hong Kong. In addition to the ongoing trade war, Hong Kong’s status as a regional economic hub has been severely damaged by the protests, with profound market reaction.15 Since protests began on March 31, the Chinese RMB fell 5% and stock market values for both China and Hong Kong dropped nearly 15%.16

What’s Next

Brexit approaches October 31 deadline. According to UK bookies, almost any outcome remains possible: a “no-deal” Brexit; a Brexit deal with withdrawal agreement; an extension or revocation of Article 50; a second no-confidence vote; a Brexit extension; a general election (currently, at 10% odds); a new Brexit/EU referendum (currently, at 87% odds).17 Even with little further clarity of a possible resolution, the UK pound gained 1% in September, UK gilts were in high demand, and UK stocks had their best monthly close in more than a year. 18

Christine Lagarde takes over as ECB president. European Central Bank’s Mario Draghi will step down October 31, 2019, leaving Ms. Lagarde with the fallout of an overly-dovish monetary legacy. Heeding Draghi’s recommendation for enhanced fiscal remedies, Ms. Lagarde has already begun pursuing an agenda to encourage the EU’s wealthier countries to spend more on programs which stimulate eurozone economies.19

Possible Warren nomination could shake US equity markets. As the odds of Senator Elizabeth Warren winning the Democratic nomination grow, experts fear US equity markets may respond negatively to proposals which target the wealthy and corporations with new taxes.20

Federal Reserve expected to cut federal funds rate. Following unexpectedly weak Institute for Supply Management data, weak consumer confidence and slowing spending, odds for cutting the federal funds rate on October 30th jumped from 40% to 80%.21 Lower interest rates could weaken the dollar.

US and China agree to reopen talks. The meetings – the first since negotiations in Shanghai in late July –offer hope that the US and China can avoid further escalation of the trade conflict, which has fulminated for nearly two years.

FX Spot Returns vs USD Sept 2019

1, 2, 5 ,7, 9, 10, 14, 16, 18, 21 Bloomberg

3 Telegraph UK. “Worst year for global growth since 2009 as trade war forces banks to slash forecasts for almost every economy.” September 14, 2019

4 The Guardian. “Trump hits out as ECB launces new stimulus program.” September 12, 2019

6 BBC.com. “Saudi Arabia oil and gas production reduced by drone strikes.” September 14, 2019

8 ft.com. “Mexico’s ‘overly optimistic’ budget raises concern.” September 9, 2019

11 thelocal.it. “It’s official: Italy’s new government gets final green light.” September 11, 2019

12 The Economist. “Why is it so hard to form a government in Italy?” April 13, 2013

13 New York Times. “Spain heads to 4th election in 4 years after failure to from a government” September 17, 2019

15 cnbc.com. “Hong Kong in danger of losing its status as financial center.”  September 22, 2019

17 www.oddschecker.com. “Comprehensive Politics Betting Odds.” October 7, 2019

19 The Guardian. “Christine Lagarde must jump-start change in Europe’s economy.” September 30, 2019

20 CNBC. “These are the taxes Elizabeth Warren has proposed in the 2020 race.” October 5, 2019

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About the Author

Scott Petruska is Chief Currency Strategist and senior advisor for Silicon Valley Bank’s global financial services group, and is based in Boston, MA. He advises clients on currency and interest rate hedging strategies, and helps them with other aspects of global banking. He regularly writes blogs on topics covering the global financial markets, conducts client seminars and webinars, and speaks at regional financial conferences.

Petruska has more than 30 years experience in the currency and interest rate markets, and has lived and worked in Boston, Chicago, New York City, Singapore and Tokyo. Prior to joining SVB in 2009, he worked at several large international financial institutions, including National Westminster Bank, Irving Trust, Bank of New York, State Street Bank and Commerce Bank. He has been an institutional trader, product developer, analyst, salesperson and advisor.

Petruska has been awarded several professional designations, including the CFA (Chartered Financial Analyst), FRM (Financial Risk Manager) and CMT (Certified Market Technician). He earned his undergraduate degree in Finance & Banking from the University of Wisconsin.