US economy sways world currency markets

The US dollar is on a roll. The currency’s gains last month took the US Dollar Index near four-year highs.

The Dollar Index, a measure of the greenback’s value against a basket of currencies including the euro, the yen and the pound, appreciated more than 3.8 per cent in a month, which all but solidified the bull trend for the dollar and primed it for an even stronger closing through the end of this year.

In its third consecutive month of gains, the Dollar Index is approaching levels last reached in 2010, and technically a move towards 88.64 will be next up for the currency. The dollar has been a big beneficiary of the one-way downwards move in the euro, which was further exacerbated last month, but the improved sentiment about the US economic situation continues to build momentum and this is converting into increased flows into dollar-long positions.

Amid a stellar US economic calendar last month filled with stronger-than-expected numbers, perhaps the key figure was the headline US nonfarm payroll report. The most recent data showed that 248,000 new jobs were added in September, well above expectations of 215,000.

The key takeaway from the report was the unemployment rate, which dropped to 5.9 per cent, below an expected 6.1 per cent and the lowest since July 2008. The improved figure caused large inflows into dollar-long positions (the Dollar Index gained more than 1.2 per cent on Friday) as the data further solidified the US recovery and increased bets that the Federal Reserve would look at increasing rates sooner rather than later.

Estimates have the Fed poised to increase US interest rates in July next year, but the US data docket showing signs of improvement leads to increased speculation of a rate hike sooner than expected – and this expected interest rate differential leads to an increased demand for the currency with the higher interest rate, in this case the dollar. With the European Central Bank in the midst of aggressively cutting rates, the euro-dollar pair is susceptible to further downsides through the medium term.

The euro’s torrid run continued through last month, with the common currency slipping 3.85 per cent against the dollar and 1.6 per cent against the British pound. The euro-dollar conclusively took out our target support at 1.28 to close just above 1.25 levels.

Technically, we predict the euro-dollar testing the 200 Month Average, which sits at 1.2214 in the month ahead, and with the current condition of the European data docket we fully expect this target to materialise.

The ECB president, Mario Draghi, last month slashed rates across the board. The main refinancing rate was cut to 0.05 per cent from a previous 0.15 per cent, the deposit facility rate was cut to minus 0.20 per cent from minus 0.10 per cent and the marginal lending facility rate was cut to 0.3 per cent from 0.4 per cent.

Although the ECB could not cut rates any further at its latest meeting last Thursday, Mr Draghi hinted at further asset purchases in the region of €1 trillion. The potential for such an increase in the ECB’s balance sheet will no doubt continue to pile the pressure on the euro, and with the data coming out of Europe showing no signs of improvement, it is not a matter of if but when Mr Draghi will pull the trigger.

The fundamental drag of upcoming ECB action will no doubt test 1.22 in the euro-dollar cross, and looking ahead to the closing months of the year this could open the door to a break of 1.20 levels. We still expect the cross to hold above 1.18 for the rest of the year.

Along with the euro, a stronger dollar will also lead to further downsides in the pound, the Australian dollar and gold in the month ahead.

The Scottish vote was a make or break for British pound forecasts, and although the No vote made the pound-dollar rally initially to 1.65 levels, a weaker second half of last month caused the cross to close below 1.60 for the first time in 11 months. The Australian dollar moved to its lowest level this year, and deteriorating sentiment from China will continue to weigh down Aussie-US dollar forecasts. The Australian dollar gave up more than 6.2 per cent against the greenback last month and we expect the weakness to continue in the month ahead with a test of 0.83 on tap.

And finally, gold is consolidating around a key support level of US$1,180 an ounce. Despite the recent bear trend in the precious metal, we expect these levels to hold in the month ahead while stabilising in the current range to close out the year.

Gaurav Kashyap is the head of futures at Alpari Middle East

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