The US dollar continues to reign supreme, capitalizing on bets for rapid-fire Fed rate increases and the troubles in other economies. Growth data for Q1 are out on Thursday and will reveal the early impact of the war in Ukraine. The numbers could be crucial for market expectations ahead of next week’s Fed meeting and by extension, for whether euro/dollar can sink towards parity.
Dollar keeps going
The relentless rally in the US dollar shows no signs of slowing down. It is a story that reflects both solid US economic fundamentals and storm clouds gathering over the rest of the world. On the domestic level, the American economy is solid. The labor market is in good shape and consumers have not cut back spending, which allows the Fed to raise rates aggressively to tame inflation.
On the global stage, the invasion of Ukraine has been a curse for the euro and the Japanese yen. Since both economies import energy products, consumers are feeling the squeeze of rising living costs. That will ultimately hit economic growth and prevent those central banks from raising interest rates much.
The lockdowns in China have made this situation worse. Chinese imports have imploded as ports have been left paralysed, which spells bad news for European exporters that rely on Chinese demand. And with expectations of slower growth in China, the yuan has taken a beating along with commodity currencies like the Australian and New Zealand dollars.
In short, the dollar has been the only place to hide – not because the American economy is exceptional but rather because other regions are struggling.
GDP disappointment?
On Thursday at 12:30 GMT, the latest batch of GDP data will hit the markets. Forecasts suggest the US economy grew by an annualized pace of 1.1% in the first quarter. That is a sharp slowdown from the 6.9% recorded in the previous quarter.
Most of this slowdown boils down to an unwind in inventories. Faced with goods shortages, many businesses loaded up on extra inventory last quarter, which artificially boosted GDP. This process is going into reverse now.
However, the Atlanta Fed GDPNow model is even more pessimistic, projecting growth at only 0.4%. This is usually a very reliable model, so a disappointment seems more likely than a positive surprise in the official figures.
In case the GDP stats fall short of forecasts, euro/dollar could finally enjoy a relief bounce. If the bulls manage to pierce back above the 1.0635 zone, the next obstacle might be around 1.0755.
Can the dollar keep going?
The Federal Reserve meets next week. Markets have already priced in 50 basis points rate increases at each of the next four meetings including this one, so it is difficult for this pricing to get much more aggressive.
In other words, we might be near the ‘peak’ of Fed hawkishness. Ultimately this will depend on inflation and growth, but if the Fed goes any faster than this, there is a very real risk something might break – whether that is the stock market or the housing market.
Normally this would suggest that the dollar’s rally is on its last legs. Of course, this is only one side of the coin. With markets in turmoil and everybody bracing for a global slowdown, the dollar is also enjoying serious safe haven demand, which could keep the trend going. The next support barrier for euro/dollar is the 1.0490 region.
For a real trend reversal, the growth outlook for the rest of the world needs to improve. Some positive news from Ukraine would be a good start. Until then, it’s difficult to argue against the almighty dollar.
