Market analysis: US dollar’s rally still has room to run

Numbers from the US show signs of strength, reinforcing the view that the Federal Reserve will raise interest rates at its next meeting.

Above, a currency bureau in Rome advertises the day's exchange rates. Chris Ratcliffe / Bloomberg

The US dollar remained well bought through the final weeks of November, with the US Dollar Index, a measure of the value of the dollar against a basket of major currencies, reaching its highest levels since 2002. A lot of the bullishness can be attributed to improving sentiment following the highly contested US presidential election, along with a sparkling data docket, which continued to show improving US economic fundamentals.

The stronger data docket through to the end of November continues to reinforce the view that the US Federal Reserve will raise interest rates at its next meeting on December 13 to 14. The markets are pricing in a hike of 0.50 to 0.75 per cent.

The numbers from the US do in fact show signs of strength. The most recent payrolls data showed that 178,000 new jobs were added last month, while the overall unemployment rate dropped to a nine-year low of 4.6 per cent. The November report is the last major release before the Fed convenes.

The euro was a big loser against the dollar last month. On the Dubai Gold & Commodities Exchange, the euro dropped to a one-year low of US$1.0529 before recovering to close 3.5 per cent lower on the month. Coupled with a stronger dollar, political developments in Italy and Austria have led risk sentiment to take a major hit. With the victory of a pro-EU candidate in Sunday’s presidential runoff vote in Austria, all eyes turned to Italy. With Monday’s resignation of Matteo Renzi as prime minister, the Italian political situation remains up in the air with the cabinet up for a reshuffle along with the nomination of a new prime minister.

The uncertainty has kept the euro on the back foot and this will continue to be case.

The European Central Bank will convene on Thursday to announce interest rates and although we expect no changes in the benchmark rate (0.00 per cent) and the deposit facility rate (minus 0.40 per cent) we will wait to see the ECB president Mario Draghi’s decision on quantitative easing. There is a combination of actions possible from the ECB. There may be an extension to the current programme, which expires in March, and we could also see a drawdown in the amount of monthly purchases, which sits at €80 billion a month.

As a result of the Italian referendum defeat and the ECB rate announcement due on Thursday afternoon, we expect trading in the euro to remain choppy and bearish. Initial support will come in at $1.0460 followed by $1.01.

The British pound was the only gainer against the greenback last month, appreciating by more than 2.10 per cent. The movement in the pound was a surprise, especially considering markets’ bias towards the dollar. The recent data from the UK has hinted at a strong core following a Brexit vote. The most recent GDP reading came in unchanged at 2.3 per cent year- on-year with the quarterly figure coming in at 0.5 per cent. Retail sales also showed an uptick with manufacturing PMI indicating expansionary conditions.

Despite these solid figures, much of the pound’s recent momentum is as a result of the unwinding of all those short positions that had built up in the months following the June 23 Brexit vote. Also improving sentiment in the pound has been the start of the UK Supreme Court’s hearing of the government’s appeal of parliament’s authority to trigger Article 50. The hearing is to last for four days, and although it will not conclude until January, parliament’s involvement is seen as favouring a softer Brexit, which would continue to support the pound in the short term. Expect the pound’s volatility to remain high. Initial upsides will be capped at $1.29 followed by $1.33. Downside support remains at $1.18.

Looking ahead, with volatility rife through the early parts of December as a result of the American and European announcements, entry opportunities to trigger fresh positions would come after the holiday period in which liquidity tends to dry up and intraday moves become exaggerated.

Gaurav Kashyap is the head of futures at Axitrader in Dubai.

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