Spark Global Limited reports:
The continued rebound in the DOLLAR index in the second half of the year was mainly driven by the divergence in economic fundamentals and monetary policy between the US and Europe, reflecting the renewed widening of the real interest rate differential between the US and Germany. At present, the factors driving the dollar rally have been marginal weakening, the dollar index further higher space is limited. However, the attraction of emerging markets to dollar liquidity spillover next year is limited, and the possibility of a sharp fall in the DOLLAR index remains low.
After hitting a low of 89.67 on May 25, the DOLLAR index has continued to rebound and recently rose above 96, not only a new high for the year, but also back to levels last seen in July. Recently, the market has paid much attention to the trend of the DOLLAR index. We have summarized and answered the following six representative questions:
What are the characteristics of the DOLLAR index this year?
A: There are two characteristics of the DOLLAR index this year:
As a result, the dollar has “appreciated” by 6.8% year-to-date (to November 19th), defying expectations of a slight “depreciation” at the end of last year.
From the process, this year’s dollar trend twists and turns, most of the stage for the performance of volatility or bilateral market.
“The dollar is likely to appreciate this year,” we predicted in our February report, “Possible Near-term REBOUND in the DOLLAR.” In his May report “Bilateral Exchange Rate Market”, he predicted that “June was the stage low of the DOLLAR index, and the trend of the DOLLAR this year may be ‘N-shaped’ or ‘M-shaped'”. Year-to-date, the DOLLAR index is “up” and n-shaped, in line with our forecast.
The reason for the “advance” of the US dollar is that the US economy is recovering and the epidemic is under control faster than Europe and Japan. The “downside” is due to the acceleration of the European recovery and the exceptionally loose monetary policy in the United States during an upturn in inflation. “Up” because the US employment gap is close to closing, the Federal Reserve started to taper QE, while the European central Bank and Japan’s recovery is lagging still maintain QE.
Whether the US dollar can “fall again” depends on whether emerging markets can get out of the impact of the epidemic and enter the high-speed channel of economic recovery, driving the spillover of US dollar liquidity. Emerging markets, however, are still suffering from repeated outbreaks and bottlenecks in the global supply chain, and there is no sign of a rapid economic recovery.
What is the main influence on dollar pricing?
A: The euro is the main source of volatility in the DOLLAR index, accounting for nearly 60% of the dollar index’s basket of currencies. The differences in economic fundamentals and monetary policies between the US and Europe are the core factors in dollar pricing. Specifically, the difference in real economic growth rate, inflation and central bank monetary policy attitude between the US and the eurozone are the main factors influencing the dollar pricing.
Why did the DOLLAR index continue to rebound in the second half?
A: Since the second half of the year, three factors have led to the continuous strength of the DOLLAR index.
First of all, the widening of THE US/Eu interest rate differential and the Fed’s relative tightening of ECB monetary policy are both positive for the DOLLAR index ahead of time.
Second, this year, the US inflation pressure has been ahead of Europe, the rise of the DOLLAR index has been suppressed, but since September, European gas prices have risen much faster than the US, Europe began to catch up with the US in industrial inflation, reducing the pressure on the US dollar from the DIFFERENCE in inflation between the US and Europe.
Finally, epidemic control has also been a variable affecting the short-term trend of the DOLLAR index in the past two years. In the past month, Europe has entered its fourth peak of COVID-19. Europe’s lead in new cases has also contributed to the rapid rise in the DOLLAR index.
Which indicator has contributed most to the dollar rally?
A: The biggest contributor to the dollar rally has been the German real interest rate spread, which explains more than 80 per cent of the move in the DOLLAR index. Since the beginning of this year, the TIPS yield spread between the US and Germany began to stabilize and recover, with significant growth in Q1 and Q3, which also correspond to the two segments of the usd index rebound this year.
Why are real interest rates in the US and Europe widening when they are already at historic lows?
A: The first reason is the difference in economic fundamentals between the US and Europe. In the second half of the year, the EMPLOYMENT situation in the United States continued to improve, and the supply chain delivery time extension led to enterprises increasing precautionary inventory demand. In the third quarter, the MANUFACTURING PMI in the United States rebounded again, but the manufacturing PMI in the Euro zone was still falling, and the difference between the two began to recover in the third quarter. Other non-American economies, such as Japan, turned negative in real GDP in the first quarter from the previous quarter, returning to recession. Differential recoveries between the US and non-US economies have underpinned the dollar index’s strength this year.
The second reason is the divergence in US and European monetary policy. In the middle of last year, the European Central Bank increased its quantitative easing policy, and the difference between the pace of the EXPANSION of the U.S. and European Central Banks began to converge. In November this year, the Federal Reserve began to reduce QE at the rate of 15 billion dollars per month. At present, the pace of the expansion of the European Central Bank has exceeded that of the Federal Reserve, and the monetary policy difference also provides support for the dollar index.
After breaking 96, will the DOLLAR index continue to rise?
A: The expansion rate of the real interest rate spread between the US and Germany, the main contributor to the strength of the US dollar, has gradually slowed down recently. The difference in monetary policy orientation of the US and European Central banks is likely to converge next year. In addition, the difference between inflation and the epidemic will not continue to widen for a long time, and may be synchronized to ease after the second quarter of next year. Therefore, the dollar multi – factor digestion into the second half. Our dollar forecast model estimates the average value of the INDEX at 96.4 in December, suggesting limited scope for further rallies.
Whether the dollar index can trend downward in the future depends on whether emerging markets can accelerate the recovery and absorb the spillover of DOLLAR liquidity. With the popularization of vaccines and the mass production of oral wonder drugs, global supply chain bottlenecks will tend to ease next year. There is room for continued recovery in emerging markets, but China’s economy is facing greater downward pressure after its early recovery. With emerging markets as a whole having limited appeal to DOLLAR liquidity, the risk of a sharp fall in the DOLLAR index remains unlikely.
Reprint indicated source：Spark Global Limited information