End of Dollar Selling

It is an ill wind that blows nobody any good. The past few weeks have been particularly difficult for dollar bulls. Adverse news has been tumbling out of closets.

The financial crisis in the US has flared up, fanned by a spate of catastrophic news. US equity prices have sunk through the low recorded in March. Expectations of interest rate hikes on the part of the Fed are waning fast. The prices of oil and of the overall commodity complex are spiralling, and on top of this the ECB actually raised interest rates by 0.25 percentage point at its latest meeting.

So the dollar has been snowed under with adverse news. However, against all odds the dollar has not been subject to another fire sale - rather the opposite!

In our view a number of crucial factors are quietly turning round the historically bearish attitude to the dollar.

First of all, there are early signs that the US capital flow is turning. The economic ills on the home front are at long last beginning to affect US investors' appetite for investment abroad. Now they are busily repatriating their money. This means that the selling pressure against the dollar occasioned by capital flows is drying out and that the dollar is now suddenly the object of demand on the part of the Americans themselves. Since the Americans are the world's greatest investor nation, this is a very important piece for the future jigsaw of the dollar.

Another highly important element that will affect the fate of the dollar has cropped up lately. The numerous advantages of the euro over the ailing dollar are beginning to crumble and are being replaced with a lot of potential ills. The monetarypolicy collision course which the ECB has embarked on in relation to the Fed after its latest interest rate hike bodes ill for the euro, particularly because the euro-zone economy is suffering.

Also, serious cracks have appeared in the joint European economic project. The spread between the yield on German government bonds and government bonds in the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) has widened to record size. That is a clear sign that investors are not willing to invest in those countries without a good-sized risk premium. Many investors are beginning to resent exactly the striking economic difference between Southern and Northern Europe. That may eventually put the euro to the stress test that it has so far avoided. The notion that one man's loss is another man's gain, which the euro has benefited from for a long time, may turn round - and with the euro as the loser.

We still firmly believe that the dollar is forming a lengthy bottom formation and that it will rise phoenix-like from the ashes. Patience is essential. Fire selling of dollars is over. Price-conscious consumers should make the last bargain buying of dollars.

'Home sweet home'

• According to the latest data about capital flows, US investors (the US is the world's biggest investor nation) are beginning to show anxiety.
• In April we saw a major change in investment appetite when there was a net capital inflow into the US instead of the usual net outflow.
• In other words, the Americans are beginning to feel the effects of the crisis on the home front.
• It is yet too early to term the latest development a trend, but the tendency bodes well for USD.

Macroeconomic pressure on EUR in future

• The macroeconomic picture - expressed by the basic balance (trade balance + portfolio flow + direct investments) abundantly indicates that the euro is at risk of running into serious problems.
• The sharply falling basic balance indicates that the ailing euro-zone economy may weigh heavily on EUR for a good many months to come.
• The illusion of the euro zone being able to come out of the current global crisis without serious dents is therefore regarded as just a worthless illusion.

The euro zone - choppy patch ahead

• One sign of clouds over the euro zone is the spread between the yield on government bonds in Germany and in the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain).
• From 5-10 bp, the spread has widened violently, which should in theory be impossible in a monetary union.
• The investors are demanding a premium for buying the government bonds of the PIIGS countries, which is an ominous sign.

Jyske Markets - FX Research
http://www.jyskebank.dk/finansnyt

The analysis is based on information which Jyske Bank finds reliable, but Jyske Bank does not assume any responsibility for the correctness of the material nor for transactions made on the basis of the information or the estimates of the analysis. The estimates and recommendation of the analysis may be changed without notice. The analysis is for personal use of Jyske Bank's customers and may not be copied.