Dollar is not Overvalued and Could go Higher: Barclays' Barth

- USD not overvalued and continues to inspire confidence.

- Trade war could be positive for US Dollar exchange rates.

- Flat or inverting yield curve a warning sign for US economy.

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The Dollar is not overvalued and could go higher, says Marvin Barth, head of FX strategy at Barclays, responding to criticism that sentiment around the currency is overwrought.

"We are well within the range of something you might consider fair value for the Dollar, so it is not like valuation is having a strong effect," says Barth, in an Interview with Bloomberg News. "On of the things which has assuaged a lot of people's concerns about this administration, going in to it from November 2016, is that US institutions work, in fact, they are really strong, and as a result you should be more confident in the Dollar."

The strategist goes on to say that despite concerns about specific policy issues and trade war, "ultimately there is a belief that at the end of the day the institutions work in this country, there is a rule of law, and that is what ultimately means you are going to get repaid."

Even in the event of an escalation in the trade war the US is "relatively more immune" than other economies presumably because it is not as reliant on exports and has a large domestic market, thus the Dollar could be resilient versus counterparts, especially those that rely heavily on exports.

One major event which Dollar traders will be watching this week is Fed Chairman Powell's semi-annual testimony to Congress where he will be asked to provide an updated assessment of monetary policy.

"We cannot really expect much new of Powell," says Esther Reichelt, FX strategist at Commerzbank. "I would be surprised if we get a further boost of the Dollar. He has already said everything there is to say a week ago. He is very bullish on the economy...Obviously he sees risks from a trade war but that is not what the Fed is focusing on, and the Fed is clearly a positive factor for the Dollar going forward." 

Another analyst who does not expect anything seismic from the Fed Chairman is Erik Nielsen, chief economist at Unicredit, although he sees a chance of a slight downgrade to the Fed's previously optimistic rhetoric on the economy.

"We may change the tone ever so slightly, but he won't change the message all that much," says Nielsen.

An issue which many commentators have been discussing of late is the flattening yield curve of US treasury bond yields. Yields are a measure of the inflation compensation investors can expect for holding different maturities of bond.

The curve is now so flat many fear it may even invert as investors see little further growth or inflation in the economy in the mid to long-term. An inverted bond yield curve is often sen as a harbinger of doom for the economy.

"Since 1960 we have had an inversion of the curve in 7 out of 8 of recessions..When you get that degree of correlation or coincidence you have to sit up and watch," says Nielsen.

Yet analysts are split over whether the indicator is right this time around given the strong economic data coming out of the US recently, and the flat yield curve is due more to the Federal Reserve not reinvesting the principle for maturing bonds it holds back in the market as it did previously.

"That said, of course the term premium is low and there are things going on with the balance sheet .. There is a possibility that it could invert and nothing happens on the economy, but it rhymes with the economic models we do on huge labour market data etc that suggests there is a potential recession on the horizon, maybe 18-months or 2-years out," Nielsen adds. 

The usual reason why the curve flattens and then inverts is because the Fed continues raising rate longer than is necessary, says Nielsen, who adds that if he was a Fed member he would be trying to "slows things down."

The US economy has received a fiscal boost from Trump's tax reforms but many analysts, including Erik Nielsen and J.P. Morgan's Gabriela Santos say the stimulus effect will wear off in 12 months or so, and when it does the US economy will start to pitch lower.

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