The US Dollar’s Impending Bout of Strength

• Pound to Dollar exchange rate reference: 1.2530 
• Euro to Dollar exchange rate reference: 1.0624

“One can wager that the US Dollar’s correction since the start of the year is probably nearly over,” goes the unabashedly pro-USD rally cry from analysts at France’s financial services bank Natixis.

Like many in the research community, Natixis have been calling the Dollar stronger in 2017 but have been frustrated by the currency's poor start to the year.

Not ready to change tune on their stronger-Dollar call, analysts at Natixis have briefed clients with the view that the driver behind the Dollar’s impending bout of strength will be driven by the US President who is tipped to turn focus to domestic economic policy over coming weeks.

Indeed, we saw the Dollar rally on February 9 when Trump told America to gear up for a ‘phenomenal’ announcement on taxes in coming weeks.

Recall that the strong Dollar rally, in place since Trump’s November 2016 victory has largely been driven by the market’s preparation for lower taxes and increases in government spending under Trump.

The Dollar slipped at the start of 2017 when markets decided that this trade had run its course - what they needed was some fresh detail on the plans.

Weighing on the Dollar however were attempts by Trump and his team to talk the Dollar down - it is their belief that the Dollar is overpriced on the global arena and is therefore hampering US exports.

However, the debate will soon back into favour for the Dollar we are told.

“One can wager that the US Dollar’s correction since the start of the year is probably nearly over, especially now that the President has turned his attention to his economic programme, and rather less to protectionist measures,” says the Naixis research note.

The timing of the shift in focus at the new administration is well timed for stock markets that were growing impatient for more fuel to justify pushing the major US indices to record highs.

“Even though it is unlikely that he will be able to carry out his entire programme, the Republicans seem prepared to run part of it through Congress,” say Natixis.

But while stock markets have rallied through 2017, until now though the Dollar has failed to rally alongside.

Some have noted that this is likely because inflation expectations have failed to rise and this suggests the Dollar will only rise if markets bet Trump’s policies will stimulate inflation.

And it appears the situation may be changing.

"USD buying particularly among leveraged investors has emerged after six weeks of selling. 'Buy USD' is also a signal that our algorithm holds (now in the 2nd day). This indicates to us the sensitivity of markets to positive news on tax reform," says Richard Cochinos at CitiFX.

Rate Rises

Then there is the US Federal Reserve which must raise interest rates by as much as two three times in 2017 to simply justify current US Dollar levels.

With this in mind, Dollar bulls will have taken heart from FOMC member Patrick Harker last week when he talked up the chances on an interest rate hike as early as next month.

Looking ahead, we will be keen to hear from Fed Chair Janet Yellen’s semi-annual monetary policy testimony before the Senate Banking Committee on 15 February.

“The Fed Chair is expected to emphasise once more the inflation risks along with the need to normalise key policy rates and, at some time, the Federal Reserve’s balance sheet. In this context, the US Dollar should remain upbeat. We see the DXY dollar index testing the 102 level,” say Natixis.

Euro to Equalise the Dollar

Concerning the headline Euro to Dollar exchange rate, Natixis are part of that school of analysts that believe the exchange rate will reach 1:1.

“In Europe, the euro will remain weakened by the ECB's monetary policy and, above all, European political risks characterised by the rise of euroscepticism in the Netherlands, France and Italy and also in Greece due to renewed fears of a Grexit,” say Natixis.

The Euro has absorbed a good deal of political risk of late thanks to the prominence given to ‘euroscepticism’ in the Eurozone over recent years.

“This has led to a rise in risk premiums priced into French and peripheral sovereign debts,” note Natixis.

Analysts say the EUR/USD will test the first target at 1.048 before parity in the second quarter.

Market has Improved Capacity for USD Strength

Meanwhile, analysts at fellow French-based investment bank BNP Paribas are also anticipating the Dollar to move higher agreeing that the reflationary ‘Trump Trade’ is not done yet and could well spark further US Dollar gains.

“As expansionary fiscal policies come back in focus, they will leverage the existing acceleration of US growth even if, as we expect, only a third of the planned programme is implemented,” say analysts at BNP Paribas pointing to a pro-growth outlook under Trump.

Markets have been also focused lately on potential trade policies such as the implementation of a border adjustment tax, which analysts at BNP Paribas argue could raise the long-term equilibrium (FEER) value of the USD.

“We maintain our view that risk reward for USD longs has improved considerably,” say BNP Paribas.

The bank’s Positioning Analysis suggests that the market is currently short USD, down from +22 in the beginning of this year.

"Therefore, there is a lot of room for new long positions to be added," say BNP Paribas.