23 March 2019
If the US dollar index falls below the 94-100 range in which it has been trading, that would signal a recession in the United States. Photo: Bloomberg
If the US dollar index falls below the 94-100 range in which it has been trading, that would signal a recession in the United States. Photo: Bloomberg

Has the US dollar run out of steam?

The net long position in the dollar index, DXY, has been contracting, while long positions in other major currencies are on the rise, data from the US Commodity Futures Trading Commission shows.

That reflects a bearish view on the US dollar.

Does that mean the greenback has run out of steam?

The non-commercial net long position in DXY dropped to 13,000 contracts last week, the lowest since June 13, 2014.

That was when the dollar began to rise after the third round of quantitative easing by the US Federal Reserve came to an end.

Meanwhile, the non-commercial position in the US dollar against eight major currencies has turned net short for the first time in 21 months.

As commodity prices started to bottom out late last year, commodity currencies have strengthened.

In fact, the combined non-commercial positions in the Australian dollar, New Zealand dollar and Canadian dollar have switched to a net long position of over 52,000 contracts recently, the highest since September 2014, from a net short position of 110,000 contracts in late January this year.

In the meantime, the Japanese yen has staged a rally since the Bank of Japan imposed negative interest rates in late January.

The yen strengthened sharply Thursday after the central bank decided to make no change to its monetary policy.

The net long position in the yen recently spiked to a record high of more than 70,000 contracts.

Nevertheless, global economic growth remains subdued, and demand for raw materials is still fragile.

It’s questionable whether commodity prices will manage to sustain their uptrend.

Also, the Bank of Japan won’t sit back and let yen appreciate indefinitely.

So, it remains unclear whether the US dollar has reversed to an uptrend, given these policy risks.

Recent economic data in the US points to sluggish growth, which has stoked market expectations that the Fed will further slow down the pace of rate hikes.

Some investors even expect the Fed to cut rates again.

In fact, the latest Fed funds rate shows the odds of a rate hike have risen above zero again since late January.

The chance of a rate hike at the Fed meeting in September is slightly above 50 percent.

Amid the dovish stance of the Fed, DXY is still under pressure.

Under these circumstances, the US dollar may head south unless the Fed launches another round of QE.

I noted late last year that the Fed has very limited room to raise interest rates.

The US economy is still highly leveraged at various levels, and the Fed won’t buck the trend of major central banks pumping more liquidity into the system.

In addition, I’m still skeptical about the prospects for US economic growth.

The US labor market has been very encouraging. By contrast, company earnings, a key leading indicator, have offered limited excitement.

The weighted revenue of S&P 500 constituents has dropped 4.5 percent, contracting for nine straight months.

And net profit margin slumped by over 1.5 percentage point from the peak level.

Since 1985, the US economy has usually slipped into recession every time the net profit margin dropped more than 0.6 percentage points. 

DXY has been hovering between 94 and 100 since the first quarter of last year.

However, if the index falls below that range, that could be a prelude to economic recession in the United States.

If so, the Fed is very likely to launch QE4.

This article appeared in the Hong Kong Economic Journal on April 28.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist

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