Date
28 May 2017
Since the financial crisis, the strength of the US dollar has been closely linked with monetary stimulus measures by central banks. Photo: Bloomberg
Since the financial crisis, the strength of the US dollar has been closely linked with monetary stimulus measures by central banks. Photo: Bloomberg

US dollar strength may not end yet

Global equity markets have shown signs of stabilizing recently, and several markets even posted an uptick.

That was mainly due to the softening US dollar and the recovery of commodity prices, oil in particular.

How long would the US dollar remain soft?

The net long positions of dollar derivatives linked with eight foreign currencies reached 164,000, worth nearly US$13 billion. And speculative net long positions of US dollar index (DXY) futures were 35,000. These show that speculators are still optimistic about the greenback.

Nevertheless, the net long positions of dollar derivatives linked with eight foreign currencies have already halved from a peak of over 360,000 in late 2015. Also, net long positions of DXY futures also continued falling from over 80,000 since early last year.

This suggests speculators are less optimistic about dollar strength. Meanwhile, the risk reversal rate of DXY have also started to fall off the peak since mid-2015, and once tumbled below zero early this month, the lowest since end-2009.

In fact, the US dollar index already completed the first wave of rally between mid-2014 and February 2015, during which it soared more than 25 percent.

Since then, the dollar has moved into a consolidation phase, while the pace of the US rate hike kept lagging behind expectations.

The DXY has once surged to 100 after the Fed liftoff late last year. However, it’s widely believed the Fed would have limited room to further hike interest rates given the sluggish global economic growth and financial market turmoil.

Heightened market volatility and the negative interest rate in Japan have prompted investors to be in the risk-off sentiment. That has triggered the unwinding of short positions in the Japanese yen and the euro.

As a result, speculative net positions in the yen have swung to net longs of 30,000 to 40,000 recently, compared with net short positions of 118,000 in mid-2015. It’s the first time to see net long positions in the yen since end of 2012.

In the meantime, net short positions in the euro have also fallen in recent months. These have weighed on the US dollar, which in turn helped to bolster global equities recently.

However, does that mean the dollar rally cycle since mid-2014 has already come to an end?

The dollar strength has been closely linked with monetary stimulus measures by central banks since the financial crisis. The euro/dollar and dollar/yen movements are closely following central banks’ moves.

Nevertheless, central banks in the eurozone and Japan are likely to expand their quantitative easing measures in the short term, while the Fed has yet to give up monetary policy normalization. In that case, it remains unclear whether the dollar has already reversed the uptrend.

Net long positions of the US dollar remain far away from substantial net short positions. Net long positions of the Japanese yen have kept hovering near the peak set between 2008 and 2012.

There is limited leeway for Japan to further relax its monetary policy.

However, it’s still too early to conclude the dollar strength has already run out of steam. In that sense, stabilizing financial markets won’t last too long.

This article appeared in the Hong Kong Economic Journal on Feb. 18.

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

JZ/DY/CG

Hong Kong Economic Journal chief economist and strategist

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