Dollar appreciation is a correction, not a long-term trend

Greenback is likely to decline if US Congress agrees on Covid-19 economic relief

The Dollar Index, a measure of the value of the US dollar against a weighted basket of major currencies, gained +1.69 per cent for the week ending September 25. Reuters

The US dollar recorded one of its strongest weeks since early May. The Dollar Index, a measure of the value of the US dollar against a weighted basket of major currencies, gained 1.69 per cent for the week ending September 25.

As I wrote in my last article on September 9, I expected markets to correct in favour of the US dollar. EUR/USD fully achieved (and broke through) my target of 1.1720 last week, while GBP/USD also comprehensively broke through my first target of 1.30 and now finds itself currently consolidating in the mid-1.28 range.

The dollar's recent appreciation is by no means a change in trend, and should be seen more as a correction. The greenback is primed for monthly gains for the first time in five months – since May, the Dollar Index has closed four consecutive months lower, a period in which it has shed 6.92 per cent.

I expect the correction in favour of the US dollar to stretch through the last few days of September, which also marks the end of the third quarter. As asset managers and corporations re-balance their portfolios, the dollar will catch a bid.

Looking ahead to October and the picture becomes a little trickier. Several of the themes raised in my last article remain key considerations – global central bank policy will continue to be scrutinised, along with the sensitivity to emerging pockets of new Covid-19 cases around the globe.

In addition to these existing themes, we are fast approaching one of the most important US presidential elections in recent memory. Margins are very thin – polls show Joe Biden still has a slight advantage but this can change very quickly.

One thing that should boost markets further and cause erosion to the US dollar will be the long-discussed proposal for the US government’s Covid-19 relief. Bi-partisan negotiations have seen this plan drag out for several weeks – but a new scaled back $2.2 trillion Democrat plan is in discussion. Any cross-the-aisle synergy will undoubtedly rally markets.

The Federal Reserve has urged the government to do its part from a fiscal perspective, and this could be a key theme in the presidential debates and US Congress in the lead-up to the November 3 elections.

Looking ahead, we have a busy economic calendar for the rest of the week, which will give traders further clues about growth recovery. China's manufacturing purchasing managers' index was released early this morning and will be followed by data on UK gross domestic product and US GDP later in the day. Expectations are for unchanged quarter-on-quarter growth in the US, likely to show a contraction of 31.7 per cent. Thursday sees the release of euro area and German manufacturing PMIs, followed by US PMI readings.

We end the week with the crucial US non-farm payrolls report on Friday, which will be the final employment report before November’s election. Expectations are for payrolls to rise to 850,000 for September, but still lower than August’s 1.37 million. Next week sees the release of the Federal Open Market Committee meeting minutes on October 7 and crucial industrial and manufacturing production figures from the UK on October 9.

Overall, I would exercise caution through the start of October – with the dollar on the front foot in September, things could change quickly. Worsening data prints should weaken their respective currencies, and I will continue to monitor US Treasury yields, particularly the 10-year yield. Averaging around 0.65 per cent over the past several months, any strength in yields going forward will translate to US dollar strength and vice versa.

I believe the dollar holds below the channel of 94.75/95, while downsides should be capped at 93.75. Considering this, for the next two weeks, I expect gold to range between $1,850 (which represents a safe, long entry level) and $1,940 levels on the upside. During this period, EUR/USD looks good to make a strong test of 1.16.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti