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The Two-Phased U.S. Dollar Rally - Global Exchanges

FICC Podcasts July 20, 2021
FICC Podcasts July 20, 2021

 

In this week’s episode, we discuss the price action in foreign exchange over the last month, along with associated fundamental developments.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 15 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson.

Greg Anderson:

In this week's episode, my cohost, Stephen Gallo, and I will be discussing the price action in foreign exchange over the last month, along with associated fundamental developments. We will contrast the price action in the second half of June, to that of the first half of July. The title for this episode is The Two Phased Dollar Rally.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX Strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX Strategist. I'm Stephen’s cohost.

Stephen Gallo:

In each weekly, like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible, so don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 4:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates, or subsidiaries.

Stephen Gallo:

So Greg, we're launching our podcasts now on the 20th of July, and we're a little more than halfway through the first month of calendar Q3. And for the benefit of our listeners, the dollar in BBDXY terms is about 1% higher in July to date. And if we take a suitable benchmark date, which we'll probably figure into our conversation quite a bit, that date being the day before the June FOMC, from that point, the dollar is up a little under 3%. So basically what I've done there, is I've identified two specific windows of time, mid June until the end of Q2, and then Q3 to date, through which we can look at the dollar strength. What do you think about that, Greg?

Greg Anderson:

So, Stephen, if we're talking about the U.S. Dollar move since the June FOMC, I think it's really important to bifurcate it like you just did. I'm not sure that June 30th is the absolute perfect division point, in terms of when the themes shifted, but it's awfully convenient for calculating returns and making comparisons. So let's just stick with it.

Greg Anderson:

Here's something interesting though. In the second half of June phase of these U.S. dollar rally, the dollar gained 1.9% against the yen and 2.2% against the loony. But thus far in July, while the dollar has gained 2.8% against the loony, has actually lost 1.6% against the yen. So if we're looking at the dollar-CAD chart, it looks like one long, continuous trend of the U.S. dollar rallying over the last five weeks. But for dollar yen, we've got a trend reversal and an obvious division between the two half periods, if you will. How does it look for your currencies?

Stephen Gallo:

First off, Greg, I think that's a great point. What you did is you highlighted the fact that the Japanese yen has been doing better during this most recent, call it Q3 phase of dollar appreciation, and we'll probably get into that in a short while. But in my vicinity, in my neck of the woods, certainly of interest is the rally in the Swiss franc versus the U.S. dollar. Quarter-to-date, this was Swiss is up, I guess around two tenths of a percent, versus the greenback, and a bit more in broad nominal terms, call it 1.3% higher. I guess one of the other key components of these global currency moves, I would point out, is the extent to which Asian currency weakness. Ex China and ex Japan has accelerated a bit in Q3.

Greg Anderson:

Interesting you said, "Ex China," along with "Ex Japan." You and I often lump all the Asian regional currencies together and just talk about the ADXY currency index. The RMB is of course the biggest weight in that index. The ADXY lost 1.1% against the dollar in the second half of June, and then it's lost another 0.8% thus far in July. So with dollar-Canada, the ADXY chart looks like one long, continuous dollar higher trend. But are you saying that the RMB, and maybe actions by Chinese officials, are moderating the ADXY decline?

Stephen Gallo:

Yeah, Greg, that's exactly right. Look, with NEM, the RMB is a relatively safe currency and that comes from years of discipline from regulators, in terms of balance of payments management. And I don't want to get lost on a tangent, but one of the questions I saw repeated after the reasonably good Q2 Chinese GDP data was, why did the PBOC bother cutting the reserve requirement ratio in light of the data? And one of the reasons that is often overlooked for the policy maneuvers, is the currency angle. Basically by softening its stance on liquidity, the PBOC has not been a direct contributing factor to this recent deterioration in risk appetite that we've witnessed, or the dollar appreciation. And it's not been encouraging an abrupt spike in dollar-RMB above 6.50. And look, the data speak for themselves. The CFX/CNY index, that's up 0.5% in July to date.

Greg Anderson:

With China being the biggest buyer of commodities, maybe that's a good point for us to transition to talking about commodity price moves over the period since the June FOMC. And it gets, I'll point out, that if we're looking at broad commodity indices, like the CRB or the Bloomberg Commodity index, we're basically flat to where we were on June 15th. But if we look at individual commodities, there's been some interesting movement. I know you follow gold closely, maybe you want to talk about what has happened with it in July versus what it did in June.

Stephen Gallo:

Yeah, Greg. Well SPOC gold is a good barometer and a really useful market variable. So the gold price is up a bit in July, certainly helped by the move lower and longer term yields, but it fell sharply in the second half of June, in the wake of the June FOMC rate decision.

Greg Anderson:

I guess that brings us to oil. Speaking of the WTI grade, it rallied a little bit between June 15th and June 30th. I'll call it roughly from $72 a barrel to $74, and we hit a high of almost $77 on July 6th. Since then, it's been all south, with crude falling about 13% to what's call it $67 a barrel, presently. And that brings up an interesting point with the dollar-CAD rally.

Greg Anderson:

In June, dollar-CAD was rallying despite oil moving higher. It was like a rally into the oil headwind, so to speak. But for July, oil is a tailwind to the dollar-CAD rally. But where the decline in oil is positive for dollar-CAD, the decline in U.S. rates should be a negative. And I guess with that, Stephen, do you want to go through the movements in the two year and the 10 year us treasury yields, quickly?

Stephen Gallo:

Right, Greg. So on yields, the two year treasury yield climbed from about 15 basis points to nearly 30 basis points after the June FOMC. But in Q3, now it's down about four or five basis points. And the move in the U.S. tenure yields is probably now so famous throughout the world, it almost speaks for itself. Down another 25 basis points in Q3, after having dropped already in Q2. But I think what's interesting is that that move can be dissected into two specific parts. One was the impact that the Fed preparing the markets for a reduction in monetary easing had on the long end of the yield curve. It seemed to cap longer term yields. But in July, the move in yields has certainly been more risk-off dominated. The move lower in yields, that is.

Greg Anderson:

Risk-off, that's the perfect expression. So let me summarize our key point here.

Greg Anderson:

The June phase of the USD rally was a Fed-on move. The July phase of the U.S. dollar rally is a risk-off move. And I guess now that we've beaten that dead horse from multiple angles, that brings us to the next logical question. When does this USD rally end and how much further can it go?

Stephen Gallo:

Well, Greg, one of the things I've got to say, one of the things that irks me is the potential evidence we've seen of stagflation. And the reason I don't like the notion of stagflation is because I think it puts central banks in a really uncomfortable position. And I know we've seen some prices come off already, particularly some raw materials prices and that's certainly a good thing, but I think risk appetite will benefit, definitely benefit, when we have firmer evidence that the inflation cycle, particularly in the United States, has peaked. So that's one of the things I'm looking for, evidence of that. In terms of how much more USD strength, I think we may yet see a $1.16 handle on EURUSD during this Greenback appreciation phase. But I think the main message I send right now is that it doesn't look to me like the USD is going to back off rapidly. I think it's going to take, maybe, at least another month or so for that to happen. And so I guess, Greg, the same question back to you. How much longer and how much further do you think?

Greg Anderson:

I'm not really sure on how much longer, Stephen. Your one month thesis sounds good. Honestly, I don't really know. For me, I'm more worried about the Delta variant than inflation. So I think we need to see angst over the Delta variant crest before the USD can crest. And I think that's probably at least a month off.

Greg Anderson:

I was just looking at a Worldometer's daily global case count metric, and it has almost doubled over the last 30 days. This is really worrying for countries that don't have all of their elderly and immunocompromised vaccinated yet. I can't see that angst going away until late August. At the earliest. But I can see slower global growth getting fully priced in the markets by September, say. In terms of further movement, as we noted in our IMM positioning report, leverage funds community has gotten rid of its short USD position. So that takes a little bit of the juice away to the upside for the U.S. USD, but maybe not all of it. I guess I think we could see maybe in another 3% upside in the BBDXY index, which would take us to a new high for it, for the year, and roughly back to where it was a pre-election.

Greg Anderson:

For USDCAD, the movement's been a little more extreme already. And so I think that maybe we will top out on a 1.28 handle, but I guess a one-day breach of 1.30 wouldn't shock the socks off of me.

Speaker 3:

Greg, I think we should just wrap it up here. We've given a number of different angles for how listeners may want to look at some of the different fluctuations that have been taking place in the FX market.

Greg Anderson:

Thank you, listeners, for sticking with us through to the bitter end of this podcast and best of luck in these thin and volatile markets.

Stephen Gallo:

I'll second that. We really appreciate all of our listeners taking the time to hear some of our thoughts on the FX market. And just a quick reminder, voting for the 2021 institutional investor survey is ongoing until the end of July. And every single vote counts, so we really appreciate your support. Thank you.

Greg Anderson:

You can find a hot button link to the I.I. survey at the bottom of any of our emailed publications from the month of July. If you're having trouble getting to it or getting through it, please don't hesitate to reach out to one of us, either by email, Bloomberg chat, or phone. Thank you again for your readership, listenership and support.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocn.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group, and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 4:

This podcast has been repaired with the assistance of employees of bank of Montreal, BMO Nesbitt Burns, incorporated, and BMO Capital Markets corporation. Together, BMO, who are involved in fixed-income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed-income and foreign exchange businesses, generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced here in may be suitable for you.

Speaker 4:

It does not take into account the particular investment objectives, financial conditions, or needs of individual clients. Nothing in this podcast constitutes investment, legal, accounting, or tax advice, or representation that any investment or strategy is suitable or appropriate to your unique circumstances, or otherwise it constitutes an opinion or a recommendation to you. BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures contracts, and commodity options, or any other activity which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the U.S. commodity exchange act.

Speaker 4:

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Speaker 4:

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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