Why is the dollar so strong again?

(Repeat May 18 message)

LONDON, May 20 (Reuters) – If investors agree on one thing this year, it will be a weaker dollar. But then how do you explain the dollar’s 2% rebound over the past month?

Inflation in the US is slowing down, and the Federal Reserve may stop raising interest rates as early as June. Theoretically, “green” should fall.

Analysts believe that several factors are likely at work here. First, a series of worrying developments – talks on the US debt limit, the state of the banking sector and the outlook for the global economy – are strengthening the dollar’s position as a safe haven.

In the meantime, there are some signs that the Fed may raise interest rates again and that more technical factors related to investor positioning are at play.

CONCERNS ABOUT THE STATE DEBT CEILING

The dollar index against a basket of six major currencies has gained around 2% since mid-April to 103 points, although it is still about 10% below the 20-year high of 114.78 reached in September 2022.

Currency strategists explain this by the fact that the US debt crisis is helping the dollar to strengthen.

Democrats and Republicans are close to an agreement on increasing the national debt limit. However, the threat of a potentially catastrophic default remains while many banks look weak.

When markets face such concerns, investors choose less risky assets: government bonds, gold and the dollar.

“Recent dollar strength is largely driven by rising demand for defense assets due to ‘unknown unknowns,’” said Esther Reichelt of Commerzbank. – How strong is the vulnerability of US regional banks and what could be the consequences of the escalation of the dispute over the US government debt ceiling?

Some worrying signs of a slowdown in global economic growth could also help boost purchases of safe-haven currencies. Data from China released this week showed that the Chinese economy did not show the expected results in April.

THE FED MAY NOT BE FINISHED YET

Alvin Tan of RBC Capital Markets doubts the safe harbor argument.

According to him, if investors were really concerned, the stock would fall. However, the S&P 500 index has not changed since mid-April and has jumped more than 8% since the beginning of the year.

Tan noted that concerns that the Fed has yet to crack down on inflation are part of the picture. A University of Michigan poll released last week found that consumer inflation expectations hit 3.2% in May, a five-year high, pushing yields on government bonds and the dollar.

Traders still expect the U.S. central bank to cut interest rates sharply later this year as a recession looms, but Tang remains skeptical.

“We see a chance that interest rates in the US may go up,” he said. “We are still not convinced by the argument that the dollar will continue to depreciate.”

NATURAL REFLECTION

According to other analysts, so-called technical factors come into play.

Investors placed large bets against the dollar. The volume of net shorts in dollars by hedge funds and other speculators last week hit the highest level since mid-2021 at $14.56 billion, according to data from the Commodity Futures Trading Commission.

Oddly enough, this setting can contribute to the rally. If the dollar strengthens a bit, some traders may be forced to close short positions and buy the US currency, which greets its appreciation.

“The dollar is very, very oversold,” said Chester Nthonifor of BCA Research. – This is one of the technical indicators. But a simple technical indicator suggests that a linear decline is highly unusual for the dollar.”

The original message in English is available under the code:

(Harry Robertson, translated by Tomasz Kanik)