US Dollar Forecast Higher Through 2016, Beware Commodity Recovery says Société Générale's Chaigneau

The great debate in global FX at the present time involves the trajectory of the dollar in 2016 and whether it can extend its multi-year uptrend.

Contributing to the debate is Société Générale’s Global Head of Rates and Foreign-Exchange Strategy who is sticking to the view that 2016 will belong to the dollar.

Vincent Chaigneau says the dollar has more to give over coming months, but, the US dollar’s strength will ultimately termiante as the currency bomes too expensive and contribute to recession in the US.

But for now the French bank remains on-consensus and sees the USD’s strength continuing in 2016.

“We often hear that the bulk of US dollar strength is behind us. We find the subliminal message (no longer worth being long) misleading,” says Chaigneau.

Leading the camp of thinkers who believe the USD has had its day is HSBC strategist David Bloom who says once the US Fed raises rates in December markets will start focussing on the trajectory of future rises.

"The timing debate is hawkish whilst the levels debate is dovish," points out Bloom.

Chaigneau argues that while the move may be more muted than over the past 18 months the dollar will still rise further in 2016 - "because it can."

The US economy is best positioned to withstand a strong currency, which will help contain home-born inflation. “Buy the USD on dips in Q1,” say Soc Gen strategists in a currency briefing ahead of the new year.

But looking further ahead, a US recession is expected to show its ugly head, inviting the dollar to crash.

"We don’t see that happening in 2016, though inevitably as valuations become more stretched, we should expect more volatility and frequent consolidation," says Chaigneau.

Three US Interest Rate Rises in 2016

The theme of policy divergence between the US Federal Reserve and other central banks is forecast to remain a major driver of exchange rate valuations in 2016.

While non-US central banks are less likely to surprise by cutting interest rates beyond what is expected in 2016 Soc Gen are expecting the US Federal Reserve to be more proactive.

As wages pick up Fed’s patience will likely be challenged and this should support further dollar strength.

Société Générale economists are looking for three hikes in 2016, one per quarter after a pause in Q1 - more than markets are currently pricing in.

It is the argument over the number of interest rates in 2016 that will set the tone for the US dollar we believe.

The dollar’s advantage against other majors is however expected to be capped by a recovery in commodity prices.

The French bank’s commodity analysts see some stabilisation in oil prices over H1, and a slow pick-up in H2.

Rising oil prices historically occur in tandem with a declining US dollar.

“In all, the case for further dollar strength is not as compelling as it was twelve months ago, but still valid,” says Chaigneau.

In G10, Société Générale expect dollar strength to be best played against currencies that are still on the rich side from a valuation basis, e.g. the CHF, GBP and NZD and currencies where central banks are still tilted towards easing (EUR, CHF) and/or most exposed to trouble in Asia-ex-Japan (AUD, NZD).

Technicals: Dollar Index Could Consolidated

Supporting the fundamental research is Soc Gen’s technical strategist Stephanie Aymes who says the US dollar index should remain in an uptrend for 2016.

This should deliver a marginal new high but this will immediately be followed by a consolidation phase in the near term.

“The Dollar Index signalled a long-term uptrend after confirming a massive inverted head and shoulders formation last year and subsequently breaking above the down-pointing triangle pattern in force since the 1980s,” notes Aymes.

These levels are currently seen at 93.25/92.50.

Aymes notes that compelling similarities with price action in the 1990s can be drawn, as the Dollar Index then formed an identical base formation  which was a double bottom coupled with an inverted head and shoulders.

The Index rallied thereafter relentlessly, with shallow consolidation, towards the projected target of the pattern and the bullish USD cycle lasted for eight to nine years.

“Thus, the uptrend in the Dollar Index is poised to persist over the course of 2016, with a significant target located at 106.60/109.00, the pattern’s projected target and retracement levels of the previous down trend,” say Aymes.

Long-dated indicators suggest further upside before they achieve a major ceiling, suggesting bullish momentum remains vivid.

“The Index looks poised to head towards 103.30/104.10, a projection for the ongoing fifth wave from an Elliot standpoint,” says Aymes.

However, a consolidation cannot be ruled out once the aforementioned
marginal highs are achieved.

Dollar Struggles

We are seeing the USD struggle to find upside momentum in the run-up to the mid-month Fed decision.

It could be that markets are simply unwilling to expose themselves to any central bank-related bets owing to the burning received on the 3rd of December when the ECB failed to deliver a policy announcement in line with market expectations.

Could these then be good buying levels? Yes, if you are inclined to believe Soc Gen.