US dollar to shake off China drag

There has been a strengthening bearish sentiment in China after it clamped down on financial markets. Ng Han Guan / AP Photo

Heightened levels of volatility as a result of strengthening bearish sentiment in China brought a clampdown on financial markets last month.

Most major asset classes closed August in the red. The US dollar index, a measure of the greenback against a basket of major currencies, closed the month more than 1 per cent lower and was at 96.05 on Sunday after earlier hitting a seven- month low at 92.53.

We have maintained our bullish bias on the dollar for the better part of the year and, despite the recent volatility, expect the losses in the greenback to be short term.

The volatility experienced in the markets over the course of the past two months, triggered by China’s slowdown, had originally pushed back expectations of a Fed rate increase as early as September. However, following its symposium in Jackson Hole, Wyoming this past weekend, the Fed maintained that US rates would be dictated by the condition of the US jobs market and US output, remaining non-committal and leaving markets wondering in the lead-up to the Fed’s next meeting which is to conclude on September 17.

As maintained previously, a rate rise as early as this month seems unlikely, but a host of upcoming US data will be key in making or breaking this expectation.

Looking forward on the US economic calendar, the monthly nonfarm payrolls report will no doubt bring with it volatility, and as a result will drive expectations. Last month’s numbers were by no means impressive, coming in at 215,000 new jobs added with the overall unemployment rate coming steady at 5.3 per cent, although with no real improvement in the labour force participation rate.

We are not convinced with the recent gains in the US labour force at present. More than 8.3 million people are actively seeking work with another 6.3 million who are working part time but would rather be in full-time employment. The participation rate has fallen to 1977 levels, and although wage growth is above 2 per cent, there doesn’t seem to be enough traction in the US labour force. Barring a major surprise in the reading this Friday, we expect the figures to be in line with previous months, showing gains of 200,000-plus jobs with the unemployment rate improving to 5.2 per cent.

Also driving Fed policy is the US inflation rate. With oil prices touching multiyear lows, inflation remains slightly below the Fed’s target rate and as a result this will not justify a rate rise.

Volatility will remain high in the US dollar through the first three weeks of September, after which a firm trend will form following the Federal Open Market Committee meeting, which takes place on September 16 and 17. During this time, expect the greenback to hold above 94.20 levels, with a move towards 98.40 likely in the month ahead. There seems to be too much volatility ahead to initiate any fresh positions, and only when the trend is established in the latter half of September should fresh positions be initiated.

As for energy, the markets continued their slide, with West Texas Intermediate hitting more than six-year lows before recovering in the final few days of last month to close above $40 a barrel. Fundamentally or technically, nothing seems to be supporting crude prospects going forward.

Sluggish Chinese demand, expectations of new output from Iran and a stronger dollar should keep any upside in crude futures in check. The move on August 27 and 28 was largely on the back of profit taking – covering of shorts – and the trend remains towards the downside, with strong support coming in the channel between $35 to $37 – the ideal level to consider long positions.

Gaurav Kashyap is a foreign- exchange expert based in Dubai.

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