A March 19th report from HSBC Global Research takes a very contrarian stance, and argues that the bull run for the U.S. dollar is coming to an end in the near future. HSBC strategist David Bloom and colleagues argue that it’s been a great bull run party for the last couple of years, but that is likely to change in the next few months as weaker U.S. economic data and the Fed finally beginning the long-awaited rate hike cycle will take the wind out of the dollar’s sails.
Bloom et al. are unabashedly contrarian: “When the world seems to be revising EUR-USD expectations ever lower, we are moving the opposite way. Our forecast for year-end 2016 is now 1.10 compared to 1.05 previously, and we believe the rate will move to 1.20 during 2017.”
Last spike higher?
Before going into an in-depth analysis of their argument, the HSBC analysts put in a disclaimer of sorts, saying there is “obviously scope for one last spike higher, as is often the case in the later phase of big bear or bull market moves, which sucks all participants into the narrative. So convinced become the participants that any rational arguments fall on deaf ears and forecasters start coming out with ever more extreme views.”
Monetary divergence already priced in
The report agrees with the mainstream view that monetary policy divergence has been a key driver in the shift in exchange rates and strength in the dollar, and “explains” most the currency movements we have already seen. Divergence, however, is old news, and is clearly priced in the valuation of the dollar.
Weight of evidence say US dollar rally is losing steam
Bloom and colleagues say the “USD bull needs feeding” and do not believe that the USD can extend in a sustained way. Even if the U.S. economy is outgrowing other G10 economies, disappointing economic data are mounting and are largely being ignored.
For example, U.S inflation remains very low. Furthermore, political tolerance for the strength in the US dollar is not limitless. Also of note, European economies are starting to pop up with some positive surprises, which is “also being ignored by the FX markets.” The HSBC analyst argue the “recalibration of growth expectations could become EUR positive.”
They also argue that the US dollar is currently the world’s most overvalued currency, except possibly for the Swiss franc. Trade positioning has highly one-sided biased toward the USD, in the market and the forecasting community, meaning a reversal is likely to be sharp and sudden. The imminent reversal in the dollar could be brought on by the first Fed hike, as historically the greenback weakens in the few months following the first tightening.