Week in FX—Dollar Parity Beckons as Euro Steadies

03/16/2015 9:00 am EST

Focus: CURRENCIES

On Friday, Dean Popplewell, of MarketPulse, offered his review of the week’s market action—including the far from quiet week in the currency markets—and provided his outlook for what traders should keep an eye on and the million dollar question now weighing on many analysts’ minds.

This past week was supposed to be relatively quiet in the currency markets. However, it was not to be once the European Central Bank (ECB) chief outlined when the EuroZone’s quantitative easing (QE) program would begin.

President Mario Draghi announced at the recent ECB meeting that the bank was officially launching its QE program on March 9. Since then, all asset classes have been on high alert. The USD has managed to hit multiyear highs across the board, being pulled and pushed higher on rate differentials. Record low European debt yields (bunds trade negatively out to 2022) has portfolio managers shifting assets out of Europe and into the US with a vengeance, while equity markets have seen both red and value most days. The pace and violence of some of the market moves have been scary. Blink and you may have missed another big EUR handle.

And yet as this week winds down, the 19-member single currency is beginning to show signs of steadying (€1.0556) after its recent plunge. The problem is that this relief may only be temporary. With the Federal Reserve widely expected to raise rates this year and the ECB’s massive bond-buying program underway, many expect the single unit to remain on course to hit parity with the dollar.

The speed of this week’s EUR decline or USD’s strength has warranted and deserved a pause. Helping to take some of the shine off the dollar has been Thursday’s weaker-than-expected US retail sales number (-0.6%). It seems that the third consecutive decline has disappointed some investors who had hopes for an increase, and in turn, has helped to reverse the rally in the US dollar somewhat (Thursday’s EUR low of €1.0495). This may slow down the building momentum for policy tightening in the US. With the focus now shifting to this week’s Federal Open Market Committee policy statement on March 18, and expectations for removal of the word patient from the Fed’s statement, USD majors are expected to flounder once again in a narrow range.

Should We Worry About the USD’s Strength?

The speed and pace of the recent dollar surge has raised a few concerns, including the threat to the US recovery, heightened risk of global deflation via the impact of lower commodity prices, and the potential damage to emerging economies. Expect these investor worries to only get louder when the dollar gets stronger. Are they legitimate concerns? Yes, but the current strength of the dollar is still some ways away from its historical highs.

NEXT PAGE: What’s On Tap for This Week?

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A rising dollar will always be a headwind for the US economy and corporate earnings, much like the risks posed by a rising EUR or GBP for their respected region or country. From the US’s perspective, the small percentage of external trade in American gross domestic product means that the strengthening in domestic demand is expected to offset the external growth loss (boost from lower oil prices and the strong labor market).

The Fed’s policy to date has been relying heavily on the US consumer to support growth and it’s only natural that it would be concerned about a stronger dollar. That’s what prudent central bankers do. Expect Chair Janet Yellen to defend the currency’s move higher more often going forward, but the Fed’s not there yet and neither is the dollar. European data is beginning to show some tentative signs that the region is moving in the correct direction toward recovery. This, too, would imply that the dollar’s strength is not a major issue just yet.

Will the Fed Remain Patient on Rates?

Will the recent dollar strength be a decisive factor on the Fed’s thinking on the timing of the first rate hike?

Some individuals would say that the dollar’s current strength is the equivalent of a Fed rate hike, and therefore, US policymakers can remain patient. A stronger dollar might simply be seen as one of the ways in which the change in US monetary policy will have its desired effect. Either way, investors and dealers are getting ahead of that first rate hike with a “buy the rumor, sell the fact” trading mentality.

The first step is seeing if the Fed omits patient from this week’s statement. The market will either go all in for a June hike or stick to September. By midweek, investors will be hoping that they have got the official nod from the Fed to proceed. If they don’t, then expect the dollar bull to look to Europe for reasons to justify their positions. After all, it’s easy and convenient to blame it on Greece.

On Tap for This Week

Central Banks again dominate proceedings this week. The RBA kicks things off down under, releasing their monetary policy minutes on Monday. The BoJ is up next with their monetary policy statement and press conference. On Tuesday, Germany releases the ZEW Economic Sentiment, their leading indicator of economic health. On Wednesday, the BoE reveals the MPC official bank rate vote. However, it’s the FOMC meeting on Wednesday that everyone will be looking to for market direction guidance.

The Million-Dollar Question

Everyone wants to know if the Fed will drop patience from the statement at next week’s FOMC meeting. The majority argues that they will, but that policy makers are expected to acknowledge the slowdown in US data by lowering both their growth and inflation forecasts. The market should be expecting Ms. Yellen to again emphasize that while the trajectory of hiking cycle is data dependent, it should be very gradual given the subdued inflation outlook and sluggish wage growth.

The unpredictable SNB are the main show on Thursday with their Monetary Policy Assessment and press conference. The Canadians will close out the week with CPI and core-retail sales data on Friday.

By Dean Popplewell, Director of Currency Analysis and Research, MarketPulse

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