Dollar Monthly Outlook

12th June 2014

The underperformance of US yields is in line with the weaker dollar seen since February this year. The outlook for the dollar is now heavily reliant on market expectations for the Fed Funds rate. Considering the Fed tapered asset purchases at their March meeting when the US economy was undergoing a severe contraction, it shows that despite what the Fed says tapering is on a pre-set course or it would take economic Armageddon for it to miss a cut in asset purchases.

The Fed has already included a discussion of the technicalities of raising the Fed funds rate in its March minutes to little market reaction. This suggests that after the tapering hysteria of last year, dollar bulls are hesitant to get burned twice. While there is a general consensus that the dollar is undervalued, the dollar index is only 19% below its long-term average. Considering the size of the Fed balance sheet and the fact that it’s still growing, this level is not unjustified. The dollar will only receive a slight lift on improved economic data but overall it will take a clearer steer on the first Fed funds hike to get dollar bulls back into the market. The Fed may begin to include more guidance on how rates will be raised and the projected outlook for rate hikes into 2015, giving the dollar a long-awaited leg higher. A stronger dollar is extremely important for the euro as the central bank struggles to set the common currency on a lower trajectory. We believe a weaker euro-dollar is now in the hands of the Fed as the euro continues to attract capital inflow despite a raft of policy action from the ECB. We see euro-dollar moving higher in the near term as aggressive talk from the ECB and their first venture into outright QE, albeit retroactively, continue to attract investment capital without the offsetting easing. We see the dollar remaining range-bound over the summer months around the $1.38 level, ending the year around $1.39/1.40 level. Euro-dollar will break clear above $1.40 into Q1, ending the three months around $1.41. The dollar should make a comeback into mid 2015 as the Fed begins to lay out their plans for hiking the Fed Funds rate. Euro-dollar is likely to approach $1.38 by mid-year.

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