The dollar's dominance remains unchallenged, despite recent efforts to diversify. A closer look at the data reveals a surprising trend.
The US dollar has gained ground this week, with better economic indicators and a steady Fed. The attack on Powell's Fed policies hasn't shaken the dollar's strength, and foreign investors continue to show confidence in US assets. The case against the dollar seems weak.
USD: Steady as She Goes
The dollar's rise this week is likely due to broader economic factors. US data, from retail sales to jobless claims, has been positive, and the Fed's Beige Book suggests a stable economy. Investors have responded by predicting a slightly higher terminal rate for the Fed's easing cycle. In turn, the DXY index is edging up with minimal volatility.
Last night's release of US Treasury TIC data for November was notable. Foreigners are pouring money into US asset markets, with net foreign purchases of US assets averaging around $100 billion per month in November. This is a significant increase from the $25 billion seen in the summer of 2024. Even foreign official sectors are buying US equities. While BRICS countries may be offloading Treasuries, these flows are dwarfed by private sector investments.
De-dollarization: A Long Road Ahead
De-dollarization is a complex process that will take time. For the dollar to weaken, US rates would need to decrease, and foreign hedging of US assets would need to increase. Today's data calendar is quiet, and there's no immediate reason to expect a dollar decline.
EUR: A Funding Currency for Carry Trades
EUR/USD volatility remains low, and the pair appears range-bound in the near term. With low volatility and high demand for high-yield and emerging market currencies, investors are opting to fund carry trades with euros at a cost of 2.00% (using the one-month implied yield) instead of dollars at around 3.55%.
Funding carry trades with euros is seen as less risky than using the yen, where USD/JPY volatility is higher, and the Bank of Japan could intervene to drive USD/JPY lower.
JPY: A Complex Picture
USD/JPY is a tricky call right now. The Japanese lower house will dissolve next week, leading to a snap election on February 8th. The conventional wisdom is that an improvement in the LDP's fortunes would be yen-negative, as it could lead to looser fiscal and monetary policies. However, past surprises in Japanese politics suggest that this outcome is not guaranteed.
The opposition, now including the former LDP coalition party (Komeito), could offer stronger resistance. If the LDP fails to convert PM Takaichi's popularity into more seats, USD/JPY could decline. There's also the threat of FX intervention, including the intriguing possibility of joint Fed-BoJ intervention to sell USD/JPY, which could be a game-changer.
PLN: The Cutting Cycle Continues
Yesterday's press conference by the National Bank of Poland confirmed that the cutting cycle will continue, despite rates remaining unchanged on Wednesday. The governor kept the February meeting open but didn't rule out a longer pause until April. This leaves various scenarios on the table, and there's low conviction on the timing of individual rate cuts.
During the press conference, the governor suggested a terminal rate of 3.50%, but a lower rate cannot be ruled out. Our overall picture hasn't changed much. We expect inflation to support further rate cuts, but we also need to monitor the labor market and wage developments.
Our economists' forecast remains unchanged - three more rate cuts in March, May, and September to 3.25%, marking the end of the cutting cycle. The market reacted dovishly to the press conference, reversing Wednesday's hawkish move. The terminal rate was priced slightly lower, and we may see a return to previous lows near 3.30%. FX was relatively unreactive, but the press conference indicates a weaker PLN as liquidity returns to the market. We expect the market to test 4.220 due to this week's NBP message.
Conclusion: A Complex Web of Factors
The dollar's strength persists, and de-dollarization efforts face an uphill battle. The data suggests that foreign investors remain confident in US assets. For the dollar to weaken, a combination of lower US rates and increased foreign hedging is needed. The story is similar for EUR and JPY, with carry trades and political factors influencing their movements. As for PLN, the cutting cycle continues, and the market's reaction suggests a dovish path ahead.
And this is the part most people miss: the intricate dance of global currencies is influenced by a myriad of factors, from economic data to political moves. It's a complex web, and understanding these nuances is key to navigating the forex market.
What's your take on these currency movements? Do you think the dollar's dominance will continue, or are we on the cusp of a shift? Share your thoughts in the comments below!
