As the euro powers towards $1.16, this may come to be seen as the week the dollar bulls finally gave up hope of a revival and accepted that the greenback is in a sustained period of weakness, or consolidation at best.
The latest blow for the dollar was the decision of two senators to join opposition to President Trump’s latest attempt to replace Obamacare, prompting the Republican leadership to abandon the strategy and some investors to conclude that legislative gridlock made tax reform an ever-distant prospect.
Yet the omens have been poor for some time. Months of investor disappointment in Trump policy execution, mingled with Federal Reserve caution on interest rate rises and lingering concerns about meek US inflation, have combined to knock 10 per cent off the value of the dollar against the euro.
“To be honest, all hopes of a major growth boost from Washington had to be abandoned some time ago,” says Commerzbank strategist Esther Maria Reichelt.
The dollar’s weakness has been consistent across the broad market. Several emerging market currencies have been making even bigger gains than the dollar’s G10 partners this year, in spite of the Fed pushing overnight rates higher — usually a trigger for extended EM declines. High-yielding currencies, particularly in EM, benefit from carry trade activity which thrives in risk-on, low-volatility periods.
Even the yen has gained on the dollar despite the Bank of Japan’s unremitting defence of its easy monetary policy, at a time not just of Fed rate rises but signs of policy normalisation among other central banks.
Those signs are the main reasons why further dollar weakness looks a reasonable bet. The dollar “is looking tarnished”, says Société Générale’s Kit Juckes, “not because there’s anything very negative facing it but because the Fed is no longer alone in tightening monetary policy”.
The stage appears set for further euro appreciation. Latest positioning data — taken before last week’s dovish remarks from Fed chair Janet Yellen as well as poor US inflation and retail sales numbers — show dollar net longs at their lowest and euro net longs at their highest this year.
While the dollar disappoints, the euro delights. Political uncertainty is off the table, eurozone growth is strong and the European Central Bank is taking steps, albeit tentative, to shift monetary policy. Mario Draghi, ECB president, is replacing Ms Yellen as the policymaker to command attention, his press conference after Thursday’s ECB meeting the key market event of the week.
But investors and economists are debating whether the euro is getting ahead of itself. The exchange rate is the most important transmission channel for the ECB, says Paul Mortimer-Lee of BNP Paribas, which worries about a rising euro having a detrimental impact on eurozone inflation.
“If Mr Draghi is going to err, it’s on the dovish side,” he says. “He has got to avoid strengthening the euro too much while setting the scene for tapering in the autumn.”
For Bill Street of State Street Global Advisors, the euro at $1.15-1.16 is approaching its long-term value, so further appreciation is less likely. “It would need a strong impulse to take the euro forward,” says Mr Street.
Similarly, Brad Bechtel at Jefferies International says that though the market is “getting itself excited for some more Draghi-style hawkishness”, the ECB president is unlikely to satisfy them. The euro looks “overbought” and the market looks “ripe for a return of some USD bullishness”, says Mr Bechtel.
Dollar bulls have other reasons not to despair. There is some progress on tax reform, says Brown Brothers Harriman’s Marc Chandler, the Fed’s balance sheet reduction strategy remain intact, and, as Mr Street says, US fundamentals “won’t fall off a cliff”.
The Fed may not move on rates much further, he adds, but dollar weakness has gone far enough and a period of consolidation will prevail.