US Dollar Could See Losses Against the Pound Over the Coming Month

The US dollar is forecast to struggle for at least another month by Australia’s Westpac bank who say the currency remains overvalued.

Since the end of March the tide has turned on the USD rally; all G10 currencies have gained against the US dollar which has seen a strong run come to an end, for now at least.

The outlook for a continuation of the strong US recovery that markets had started to take for granted now feels much less certain, prompting economists to begin revising down annualised US growth forecasts. Market players have responded by re-pricing the dollar and selling it to lower levels.

A fresh slump in USD came mid-May when weaker US data in retails sales, pushed Fed rate hike prospects further out, sending the US dollar basket (DXY) to its lowest level in 2015.

The EURUSD was able to climb to 1.1381, its highest level since February from 1.0468 in April.

The pound to dollar exchange rate (GBPUSD) meanwhile hit its best level of 2015 at 1.5815, it looks like a solid base has formed at 1.4500 at which buyers tend to rush back into the market to buy cheap sterling.

The USDJPY was range bound between 119.11 and 119.40. “USDJPY traders will be focused on 118.40 support as a bearish trigger for an extension to 116.60,” suggests Swissquote’s Peter Rosenstreich from Swissquote Bank.

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More Weakness Ahead

How low can the US dollar index (DXY) go then?

Richard Franulovich at Westpac says he sees little little reason to steer away from a cautious USD outlook and stick with a negative week and month ahead bias.

“Our DXY fair value model, based on relative growth, yield and CB balance sheet trends, as well as world oil prices suggest the USD remains fundamentally overvalued, while consensus growth prospects for 2015 still look too high at 2.8%, with barely 0.4ppts trimmed from 2014 prospects due to the high USD and the dislocation in the energy patch,” says Franulovich.

Westpac analysis suggests that these two enduring negatives could easily shave 1ppt from 2015 growth.

“The PMIs should underwhelm next week while the minutes may weigh on the USD too, assuming they convey the same sentiments as the statement which was more cautious on the economy.”

USD Needs a Stronger US

The importance of US data to the the dollar appears obvious, but Morgan Stanley argue that much of the recent USD gains come on the back of issues elsewhere in the world.

"Deflationary pressures, falling commodity prices and aggressive monetary easing outside of the US meant that USD could appreciate even with US bond yields staying low," notes Evan Brown at Morgan Stanley. "Deflationary risks have subsided in much of DM, aided by a rebound in commodity prices. Central banks are occasionally surprising markets by doing less, rather than more, easing. In this environment, the long USD trade requires clear signs of durable US growth."

Morgan Stanley argue that the USD revival needs a pickup in US economic activity. "Yes, labor markets are looking healthy overall, but we’d like to see more evidence of consumers putting income to work before we add fresh USD longs against the majors. That said, we are not in a rush to add USD shorts against any currencies, given that a durable global recovery is unlikely without a strong US consumer," says Brown.

Longer-Term: The Trend Higher Remains Alive

The short- and medium-term continues to look troublesome for the US dollar. However, the longer-term cyclical period of strength is not yet done; it is not nearly close to being done in fact.

As the above image shows, when taking a longer-term view the US dollar index has plenty of historical context within which to be at higher levels. The USD tends to move in 6-7 year cycles, and as such we are at the bottom of the next cycle of strength.

We sit and wait for the next stage of the rally which will only commence once US economic data releases start to confirm economic growth is rising at a solid pace once more after the recent soft patch.