Dollar Strength Pushes Sterling and Euro onto the Back-foot

- USD tends to do well in May
- Markets eye Friday's payrolls report
- EUR/USD threatens break below 1.20

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The U.S. Dollar is a standout performer and is advancing by close to half a percent against the Euro and a quarter of a percent against the Pound, at the start of what is typically a strong month for the U.S. currency.

The performance resulted in the GBP/EUR cross advancing by a quarter of a percent.

The Dollar therefore appears to be a dominant driver at present but we would expect some Sterling-specific influences to come to bear on markets on Thursday and ahead of the weekend as the Bank of England is due to deliver a crucial update.

The Dollar is the worst performing major currency of the past month, however it is the best performing currency of the day, a sign perhaps that selling the Dollar might be running into some positioning headwinds:

"April saw an arduous month for the dollar falling consecutively for four weeks. May, however, has seen the dollar drift higher, with investors eager for US economic data to show a roaring recovery which may force policymakers’ hands into normalisation policy," says George Vessey, UK Currency Strategist, Western Union Business Solutions.

"A major factor that could be associated with strong seasonal demand for U.S. dollars in May may well occur again this year, after being absent in 2020: a strengthening of the U.S. economy," says Martin Miller, a Reuters market analyst.

A Reuters study of the USD index's performance for each May since 2000 shows it has risen in 13 of the last 21 years or 62% of the time.

"Dollar buying in May seems to coincide with the strengthening of the U.S. economy in the second quarter," says Miller.

Vessey says a "plethora of U.S. economic data is to be released between now and week-end, with the headline U.S. jobs data to be released on Friday."

The Pound-to-Dollar exchange rate (GBP/USD) is quoted at 1.3874, which puts it back into the mid-point of a range occupied by the pair since mid-April.

The Euro-to-Dollar exchange rate (EUR/USD) is back at the psychologically and technically important 1.20 level, having been as high as 1.2150 in the previous week.

"EUR/USD has reversed on the gains seen over the past few weeks breaking below the supporting upward trend line. The pair remains above the $1.20 handle but should this fail the next region of support will be offered around the $1.1945-50 where both the 200 and 50 daily moving average currently reside,” says Vessey.

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With eyes on Friday's jobs report, Vessey says market sentiment seems to be that investors will start to anticipate a hawkish move from the Federal Reserve (Fed) much quicker than anticipated.

The Fed last week sent a resolute message that it is in no position to start winding down its quantitative easing programme (known as tapering) as it was their judgement that the labour market would need to accelerate its ability to create jobs significantly.

Therefore, should the non-farm payrolls report due on Friday beat expectations investors might buy Dollars in the belief the Fed will have to blink and start tapering ahead of raising interest rates.

"The dollar extended gains on Tuesday, partially unwinding a month-long decline as investors weighed chances that interest rates will be forced higher by the roaring recovery .... FX traders built up a speculative dollar short position in recent weeks, leaving them vulnerable to a bigger squeeze higher in May," says Miller.

Currency markets are heavily invested in central bank policy making, with those currencies belonging to central banks that are looking to bring forward the time of their first rate rise being rewarded.

One only needs to look at the Canadian Dollar which benefited from last month's decision by the Bank of Canada to taper their asset purchases.

The Bank of England will meanwhile be in the frame for a similar move on Thursday when it delivers its monthly policy updated and quarterly Monetary Policy Report.

Crédit Agricole say a 'taper' this week could see the BoE cutting its weekly QE purchase pace from £4.4BN a week to £3.2BN.

Despite a strong start to the week for the U.S. Dollar, one major investment bank is cautioning against expecting a strong trend of appreciation.

"Despite continued US growth outperformance, we see some offsetting factors for outright USD strength as vaccine demand loses pace in the US and catches up in the rest of the world," says Erick Martinez, an analyst with Barclays.

A key tenet of U.S. economic outperformance over 2021 has been the country's rapid vaccine rollout which has been aided by a strong vaccine manufacturing base in the world's largest economy.

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But Barclays say in a weekly foreign exchange strategy briefing note that supply might not be a headwind to U.S. vaccinations going forward; rather it is increasingly clear demand is a potential issue.

Barclays cite last week’s vaccination statistics in the U.S. which showed a slowing of newly administered doses, with the 7-day average decreasing from 3.4m in mid-April to 2.7m at the end of the month.

Martinez says this does not appear to be caused by supply constraints, but slowing demand.

"While vaccine reluctance could lengthen the timeline for a full economic recovery, it should also reduce concerns around the potential overheating of the US economy, while it implies more room for a catchup from the rest of the world as vaccinations speed up elsewhere on expanding supply," says Martinez.

"That being said, the BoE could ultimately decide to wait until June and even August. This would mean slowing the pace of purchases more aggressively, however," says Forrester.