The Dollar Forecast to Recover Against Pound + Euro Near-Term by ABN AMRO's Boele

Above: Georgette Boele, currency analyst at ABN AMRO Bank N.V. Image: Pound Sterling Live, ABN AMRO.

The US Dollar, one of this year's worst-performing currencies in the G10 club of the world’s largest currencies, is tipped to make a comeback in the near-term.

The prediction for a Dollar recovery is made by analyst Georgette Boele at ABN AMRO Bank NV who does however caution that the recovery will be relatively limited when compared to past bouts of Dollar strength.

Boele says she expects in the coming months and quarters an improvement in US economic data, further rate hikes by the Fed, a rise in US Treasury yields and somewhat higher US real yields.

The call is made hours after the US Federal Reserve conducted their May policy meeting where they opted to keep policy settings unchanged.

However, it was the relatively upbeat, steady-handed tone delivered by the Fed concerning the economy that saw markets rush to bet that the Fed would raise interest rates at the June meeting sending the Dollar higher against the Euro and Pound in the process.

A recent slowdown in US economic activity had seen markets start to doubt such a rate hike was coming and they sold the Dollar instead.

Potentially taking a lead from the US Fed’s confidence in upcoming US economic performance, Boele believes data should once again start becoming more supportive of the Dollar.

“Recently US economic data have come in below the expectations and this has also added to the downward pressure on the US dollar especially versus the euro and sterling,” says Boele. “In the coming months and quarters we expect an improvement in US economic data, further rate hikes by the Fed, a rise in US Treasury yields and somewhat higher US real yields.”

ABN AMRO believe this should result in a recovery of the US Dollar towards 1.05 in EUR/USD and 1.25 in GBP/USD.

However, the upside will be limited in Boele’s view as investors will probably take any rally as an opportunity to off-load long positions in the Dollar.

The bet that the Dollar will continue rising has been one of the most popular in the trading community which holds historically-elevated bets in favour of the Dollar. At some point many traders must exit this trade.

The next catalyst for foreign exchange markets will be the outcome of May's US employment and wage data due out on Friday, May 5.

Focus will be on jobs with market eying a print of 194K versus last month’s gains of 98K.

Howeer the main focus will be on wages as the Federal Reserve has made it clear that it considers the economy to be at near full employment and therefore any incremental gains in jobs are not nearly as significant to their policy objectives as the rise in wages.

"To that end even if the jobs number misses but average hourly earnings rise by the expected 0.3% the dollar could see a strong rally," says Boris Schlossberg, analyst with BK Asset Management in New York.

Strong wage growth would confirm the Fed’s thesis that growth is finally having an upward effect on price levels demanding a return to normalization of monetary policy.

"If however, the wage data comes in soft much of the bullish case for a rate hike could evaporate," says Schlossberg.

Regardless of the near-term volatility ABN AMRO expect the US Dollar to weaken across the board next year because of lower US real yields, a deterioration in the US growth inflation mix and other central banks moving towards more restrictive or less accommodative monetary policy.

Too Early for an Agressive Sterling Rally

Since March, Sterling has done well mainly because investors have closed some of the excessive net short positions taken against the currency.

Despite this, speculative short positions are still huge.

ABN AMRO expect that it is too early for an aggressive rally in Sterling because  uncertainty surrounding Brexit remains high and this will likely cap the upside in Sterling.

However, we do note risks to ABN AMRO’s near-term bullish assessment on the Dollar.

“An easy win for Theresa May next month combined with a pick-up in UK economic data could help GBP/USD break through the 1.30 barrier in the coming weeks. As we lead up to the election on June 8th June, UK economic data will be just as important as the polls for traders to keep an eye on,” says analyst Kathleen Brooks at City Index.

Note that momentum still remains favourable to Sterling from a technical perspective and we would suggest further signs of deterioration are required before the short-term trend turns negative.