For the dollar, the background environment in the first half of this year has been fruitful. Europe’s financial flagellation has contributed to a surge in safe-haven demand and risk aversion, with the dollar as a beneficiary. Also, in contrast to most other advanced economies, the US recovery has looked reasonably secure, certainly a lot better than in Europe. Sovereign wealth funds have been buyers of dollars, their conviction in the safety of the euro diminishing.
And yet, it could be contended that the dollar’s performance has actually been rather indifferent. Indeed, it is actually quite surprising that it has not done a lot better. For instance, the dollar index is up less than 2% for the year-to-date, although to put this into context it is worth recalling that the dollar recorded a rise of 8% in the second half of 2011. Traders and short-term speculators are incredibly bullish on the greenback – according to the CFTC, cumulative long positions in the dollar (against the euro, yen, Aussie, CAD, Kiwi, Swissie and Mexican peso) were above 300K last week for the second week running, a record.
In addition, the US recovery is looking more vulnerable these days. Fed officials are especially mindful of the impact of the ‘fiscal cliff’ pencilled in at the end of this year, which could drag the economy back in to recession if it’s implemented in full. Ahead of this week’s FOMC meeting, some policy-makers have intimated a willingness to ease the stance of monetary policy further. This may take the form of an expanded Operation Twist (the current program is worth USD 400bn) and possibly an extension to their guidance on short-term rates. If the economy does lose some further traction and/or the Fed opts for aggressive easing measures, then the dollar may well fall out of favour.
There is also the question of the outcome of the Presidential election in early November and the likelihood that the US government will hit its debt limit-ceiling of USD 16.2trln late this year. Last summer the dollar dropped sharply amidst an acrimonious debate in Washington over the issue. A repeat of this political brinkmanship would surely weigh on the US currency.
Dollar bulls need to be alert, notwithstanding the ongoing car-crash that is Europe.
This article is contributed by FxPro. You can view the original article here
