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Early Apogee for the Dollar? - Global Exchanges

FICC Podcasts 19 octobre 2021
FICC Podcasts 19 octobre 2021


Disponible en anglais seulement

In this week's episode, we talk about the 1% decline in broad US Dollar indices over the past week, the potential causes for this reversal in momentum, and what this might mean for the outlook for the remainder of 2021.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

Podcast Disclaimer

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Greg Anderson:

Hi. Welcome to episode 22 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost, Stephen Gallo, and I will be talking about the 1% decline in broad US dollar indices over the past week, the potential causes for this reversal momentum, and what this might mean for the outlook for the remainder of 2021. The title for this episode is Early Apogee for the Dollar?

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible, so don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates, or subsidiaries.

Stephen Gallo:

Okay, and so the day on which we're podcasting episode 22 of Global Exchanges is October 19th, 2021. And given our theme for this week, Greg, I'm going to pull up a daily chart of the Bloomberg Dollar Index, also known as the BBDXY. I'm looking at some reasonably noteworthy price action. The index put in a high for the year on September 29th, and then it almost managed a full retest of that high on October 13th, which was last Wednesday. Now, today, it's broken back below short-term support at 1160, and trades about 1% below that high I just mentioned.

Stephen Gallo:

I'm not a qualified technician, Greg, but the price action looks like it may have formed a rounded top. What say you, Greg Anderson?

Greg Anderson:

Stephen, I don't consider myself a fully immersed technician either, but a market with as many technicians as FX, one has to know the basic patterns and respect their potential to create self-fulfilling prophecies. And yeah, BBDXY does look like it has potentially formed a rounded top.

Greg Anderson:

We published a giant forecast pack, our FX quarterly, back on October 7th. That was only 12 days ago, but in market time, it already seems like forever ago. Our thinking then was that the US dollar would rally another percent or so during the remainder of October, then enjoy maybe another half a percent or so of a small confirmation rally after the Fed meeting on November 3rd, when we expect and still expect the Fed to lay down its taper timetable. Then at that point, so, say, maybe November 5th or so, we expected the dollar to reverse direction and move lower for the year's end.

Greg Anderson:

Now, 12 days later, it sort of looks like we got that pattern right, but what we thought would take a month, instead took a week. And it sort of feels like the FX market has moved on from taper being the driving theme to trading other themes that aren't as clearly US dollar bullish.

Greg Anderson:

The other thing I'll point out is that market positioning had become fairly extended in terms of the long US dollar against everything else trade. And it looks like leverage money may have trouble hanging on to that trade all the way through November 3rd.

Stephen Gallo:

Yeah. Greg, I think that is a really good shout about overextended positioning in the long dollar trade, and also the fact that we're almost always reassessing currency fundamentals as new developments take shape. So tell us a bit more about these themes you think some investors in FX are now trading, which aren't so dollar bullish.

Greg Anderson:

With, well, where it is, Stephen, I think one of those themes is which central banks are going to hike in 2022 and how much. And with that, a futures contract that has gotten a lot of play in October has been FFZ2, the December 2022 Fed funds future. Over the past 10 days, that future has moved to fully priced in one Fed rate hike by the end of 2022. But frankly, that hasn't kept pace with the number of 2022 rate hikes priced in and many other currencies' curves, like Canadian dollars or New Zealand dollars, for example. Then I'll point out that today, as the US dollar has taken a dip, we've seen about two and a half basis points of implied Fed rate hikes taken out of the December 2022 Fed funds future.

Stephen Gallo:

Right, Greg. What I've done is I've followed your lead and pulled up a chart of the DEC '22 Fed funds future, and I can see exactly what you're talking about. But I also want to give listeners a feel for a dollar risk factor that you and I have been talking about for some time. That factor is the reappointment of Jay Powell to lead the Fed. I think we've seen some noteworthy price action in the futures attached to his reappointment overnight, and therefore, the implied odds. So tell us, Greg, what's been going on here and do we still need to classify the risks around Powell's status as an outlier for the dollar?

Greg Anderson:

Really good point, Stephen. Markets have known all year that a Powell reappointment decision would likely come in October or November, and that there was a chance that he wouldn't be reappointed. But for much of this year, it seemed like the probability of him not being reappointed was like 20% or less. Then we got the Fed trading scandals, and his probability of reappointment suddenly became more of an issue for markets to watch.

Greg Anderson:

Yesterday, a left-leaning website released an accusation that Powell himself had sold stocks based off of private information. In the predicted futures market, it was sort of a political futures market, the implied probability of Powell being reappointed went from 78% to 65% within a few hours. If we're talking about a 35% risk now, risk of him not being reappointed, that's something way different than a 15 to 20% probability risk. A risk that big needs a discount attached to it.

Greg Anderson:

So maybe that does explain the move in FFZ2 today and a move lower in the US dollar. We have to price in the risk that the Fed Board of Governors's composition may shift massively next year, and the Fed may not be nearly as hawkish as other central banks.

Stephen Gallo:

Right. So we're talking about a potentially seismic shift here for the dollar if these risks we've been mentioning are realized, Greg, especially with the high inflation backdrop right now.

Stephen Gallo:

So with that in mind, I want to ask you about an interesting case of positive correlation and co-movement year to date, and that is between the price of crude oil and the US dollar. So just pulling up a chart year to date, it looks, to an extent, like oil up has meant US dollar up. Can you break down this relationship for us, Greg, and discuss briefly what might cause the relationship to no longer exist?

Greg Anderson:

Briefly? It's a long story, but I'll do my best to be brief. Let me start by saying that until now, FX markets have traded oil higher in the traditional way as a factor that impacts balance of payments flows. So oil higher has meant CAD and NOK stronger, and also euro and yen weaker.

Greg Anderson:

Well, guess what? Euro and yen have bigger weights in the US dollar index than CAD and NOK. So if the market just trades oil that way along those crosses, then euro/CAD lower due to high oil prices pulls up BBDXY, and in any other broad US dollar index configuration. Where the US has a balanced trade account in terms of energy, I think that's the story for oil higher corresponding with BBDXY higher.

Greg Anderson:

Now, if we start to trade the oil theme differently and suddenly the price of oil becomes the determining factor for which central banks will hike and how much, then the nature of this correlation might change. To be more specific, if we ended up with a really dovish Fed composition next year that won't hike as oil prices rise, whereas some other central banks choose to hike, then all of the sudden, the correlation could flip or at least go away. Let me just put it this way. It's not a correlation that I would trust right now.

Stephen Gallo:

That makes sense to me, Greg, and you know what? You touched upon a couple of concepts in your commentary regarding balance of payments flows and currency weights in the US dollar trade weighted basket. So I want to mention the Chinese renminbi because it has a big weight in the dollar basket, so therefore, it can drive directional shifts in the US dollar. And China is also a big net petroleum importing nation.

Greg Anderson:

So as the US dollar has weakened over the past few days, there has been noteworthy strength in the Chinese renminbi. The 640 to 650 trading range in dollar China, that held for the better part of four months, broke today. A big RMB rally brought dollar China below 640 for the first time since June. Do you want to walk us through that?

Stephen Gallo:

Yeah, Greg, I can. And there are a few things worth mentioning here regarding China. In as much as China's fundamentals haven't been screaming, "Get long of the RMB," I've done my level best to classify the move in dollar China you described not as a growth and reflationary RMB rally, but more as an FX management RMB rally.

Stephen Gallo:

This management of the currency by the central bank touches on a concept I've described in the past, which is that the RMB often needs to be viewed by investors as a counterweight to the US dollar. One example would be between late May and late July, a higher dollar RMB exchange rate was a counterbalance to Chinese capital inflows, a disproportionate level of RMB bullishness from the perspective of regulators, and the means of counterbalancing tighter credit policy in mainland China.

Stephen Gallo:

We can't forget, and it's important to remember, the PBOC was one of the first movers on tightening credit before other major central banks this year. But more recently, so as opposed to that situation I just described, more recently, a lower dollar RMB exchange rate has been used to counter dollar appreciation.

Stephen Gallo:

So I'm satisfied with the idea that PBOC did not have a preference for its currency to feed a sharp move higher in the dollar by depreciating as a result of strains in the local property market. For instance, when the Evergrande news broke. Especially with global inflation pressures rising sharply in recent months.

Stephen Gallo:

So here we are, beneath 640 in dollar RMB. So the question is, "Would I be a buyer of dollar RMB right now?" My honest answer is I don't know. What I do know though is that given China's fundamental backdrop, the PBOC's tolerance threshold for RMB appreciation is probably not miles away. So I would be cautious about getting super bulled up on the RMB right now in this latest move.

Stephen Gallo:

That being said, and this drifts back to the point you made earlier about Jay Powell's reappointment, Greg, if it comes to the point where we need to discount a much more dovish Federal Reserve, there isn't much the PBOC will be able to do but shoulder a portion of the dollar depreciation. But from that point forward, once again, I would expect the PBOC to act as a counter to dollar depreciation. I think what we have to accept is that the RMB is a super low vol, super rangy currency, and that's exactly how the PBOC wants it.

Greg Anderson:

So if China allows the RMB to appreciate a tad to counter some of the imported inflation from higher global energy prices, would the rest of Asia follow suit so that we see widespread appreciation among many of the Asian regional currencies?

Stephen Gallo:

The answer is yes, Greg. I think there's room for that to happen in a limited fashion. One of the reasons for that, one of the reasons I think that's the case is the extent to which Asian regional currencies have depreciated against the US dollar and the renminbi year to date. So if the PBOC is removing upward pressure from the US dollar, I don't think this is something that the central banks of South Korea, Thailand, Singapore, and Malaysia would be too displeased with at this stage. I guess a relevant point would be that in a rising inflationary environment, which we now have, these central banks don't want to be forced to tighten policy more aggressively, because their currencies are so weak.

Stephen Gallo:

But just as an important side note, last week we saw the Monetary Authority of Singapore increase the slope of the Singapore dollar's trading band against the basket of currencies. So I think the signal here is that some of these central banks are at or near the limit of currency depreciation they're comfortable with.

Greg Anderson:

Great points, Stephen. It sure looks like it's setting up to be an interesting next few months.

Stephen Gallo:

Yeah, Greg. And if you remember, last week when we were discussing the European energy crisis, I said it was going to be an interesting winter, I think. So we're two for two in terms of potential intrigue. Let's wrap up episode 22 here. Until next time.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Inc., and BMO Capital Markets Corp, together, BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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