The Dollar strength story has returned to the scene with a vengeance, and it represents a risk of crumbling its counterparts across the globe.
The Dollar Index has advanced to its highest level since June 2017 as trading commences for the new week, which represents a 17-month high for the Greenback and a milestone low for the likes of the Euro that has consequently declined to its lowest level since June 2017 on renewed Dollar strength.
More woes for emerging markets and the Chinese Yuan ahead?
This rally in the Greenback is going to ask a lot of questions over the resilience of its counterparts, but the largest risk that investors will probably be evaluating is what does this mean for emerging markets? Dollar strength was one of the key themes behind the prolonged weakness in emerging markets that took place over the summer, and this news over the Greenback rallying to new highs is going to bring questions over whether another round of emerging market weakness should be expected before we conclude 2018.
What will be one of the most interesting themes to monitor is whether this new round of Dollar strength is enough to push the Chinese Yuan “over the edge” and within touching distance of the psychological seven level against the USD. Dollar dynamics has been an ongoing challenge for emerging markets throughout this year, but the resilience of the Chinese Yuan to not meet 7 against the USD is seen as one of the last hurdles of defense for emerging markets before another brutal sell-off.
Basically, if this relentless drive for the Dollar persists further meaning more highs for the Greenback and if this is met with the Yuan finally breaching 7 against the Dollar we are looking at a combination for yet another round of pain for emerging markets before an already eventful 2018 concludes.
What has encouraged another rally for the Greenback? Trade tensions or Fed policy?
The other question to ask is what exactly is behind the push higher in the Greenback? Pointing the finger towards the Federal Reserve and central bank divergence regarding ambitious interest rate policy in the United States is the easy answer, but not necessarily the right one when you consider that the Fed has been consistent with its communications to raise US interest rates further for a long time. US interest rate policy in the United States has been priced into the USD a long time ago, meaning that there is likely a different culprit behind the renewed push for the USD.
I would personally attribute the move to growing skepticism over whether President Trump was sincere with his narrative that a trade deal with China might be close. While we haven’t seen any drastic changes to this narrative, we haven’t seen a continuation of this optimism either, which does suggest that this could have been a strategic ploy to put the pressure on China before the scheduled meeting at the G-20 summit in Argentina later this month.
We do overall maintain the view that a trade deal needs to be announced soon, otherwise it is very difficult to pinpoint when emerging markets can really bounce back. This means that a trade agreement is consequently needed for the Yuan, like many other emerging market assets to recover from a painful 2018.
Gold decline suggests Dollar drive driven by trade skepticism
Gold has fallen in line with the USD drive, meaning that the current rally in the Greenback is not a reflection of a safe-haven spree from traders. This does weigh in line with the view that investors are piling up bullish Dollar bets, which makes me more suspicious that this move has been encouraged by skepticism that a trade agreement with China can really be agreed in November.
Pound at risk once again to lower 1.20’s
The Pound has been another victim of a brutal day in the FX markets, but it is also suffering from a return of investor concerns over the daunting prospect of a hard-Brexit scenario.
The Pound can still fall further on hard-Brexit fears, and I would still not rule out the potential of a dive to the lower 1.20’s in the GBPUSD if the prospects over a deal between the United Kingdom and European Union being announced before year-end do deteriorate once again.
Euro could meet 1.10 before end of month
Another currency to keep an eye on this week is the Euro. The EURUSD has fallen below 1.13 and a sustained breakdown below these levels represent a risk that the EU currency can drop to 1.11 as soon as this week.
If concerns over the budget stand-off with Italy resurface and are met with pessimistic data out of Europe that an economic slowdown can’t be avoided, concerns that the ECB will not be able to raise EU interest rates next year will arise and we will be looking at a risk of the Euro potentially dropping below 1.10 before November concludes.