Dollar Rally On Verge Of Coming Unstuck From Longer-Term Forces

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by Tyler Durden
Thursday, Sep 07, 2023 - 05:40 PM

Authored by Simon White, Bloomberg macro strategist,

Short-term tactical overbought conditions in the dollar is coinciding with continued medium- and longer-term signs of weakness in the currency, indicating the recent rally will soon come unstuck.

The dollar’s had a decent run these last two months, with the DXY rallying about 5.5%, and the downwards trendline since October being broken to the upside. Nonetheless, tactically the currency is now stretched, with technical indicators, such as RSIs and Bollinger bands, registering overbought readings.

These tactical headwinds will be reinforced by ongoing longer-term indicators of dollar weakness.

First, there is my medium-term leading indicator for the dollar based on long-run rate expectations, which is still pointing down.

This tallies with the message from the real yield curve, which has also yet to change its fundamental trend, and therefore remains consistent with a lower dollar in the medium term (three to six months).

Longer-term factors are consistent with the primary trend of the dollar remaining lower.

Foremost is the US’s swollen fiscal deficit, larger than it’s ever been in GDP terms outside of wars and recessions (assuming we are not yet in a recession).

Lower fiscal deficits typically lead a weaker dollar by around 18-24 months.

The inflation-inducing combination of large government expenditures and expansive central-bank balance sheets is a formidable headwind for the currency.

On top of that, the rest of the world is slowly moving away from the dollar.

That does not mean the dollar’s dominance will end soon, but the slow waning of its importance represents a headwind that will build over the years.

The chart below shows that the bounce in real commodity prices that would normally take place after dollar weakness has been subdued thus far, in an indication a lower dollar – as its marginal use is declining – is not having the same stimulative impact as it once had.

Speculators’ positioning in GBP and EUR remains long according to COT data, suggesting the dollar shorts have not thrown the towel in despite the up move, and are thus not weak hands.