The UK referendum is three months away. Three-month options are a common benchmark for various market segments from speculators, to fund managers to corporations. Events over the past week have raised the risks that the UK votes to leave the EU.
In our work, we have argued that the dollar is having its third significant rally since the end of Bretton Woods. The first rally was associated with Reagan though it began under Carter and followed 100 bp hike by a new Federal Reserve Chairman (Volcker).
On a real broad trade-weighted basis, the dollar appreciated by more than 50% over the seven years and in 1985, the G7 met at the Plaza Hotel in NY and agreed to coordinate intervention to drive the dollar lower.
The cry that the dollar has peaked is gaining ground. We are not convinced. The macro-fundamental case remains intact. Divergence between the US and other high-income countries continues, even if at a more gradual pace than the Federal Reserve expected a few months ago.
The reversal of the US dollar’s gains half way through Draghi’s press conference has undermined the near-term technical tone. The risk is on the downside, at least in the first part of the week, ahead of the FOMC meeting.
The Canadian dollar’s advance continues. Neither the widening of interest rate differentials in the US favor nor a poor employment report has managed to buckle the Loonie. Oil and the general risk-on mood trump the other concerns.
In addition, investors are concluding that fiscal stimulus will reduce the possibility of additional monetary stimulus. The implied yield on the June BA futures is now the highest since last June.
The Canadian dollar appears vulnerable. It remains firm while the US two-year premium over Canada has risen sharply. Like others, we do not expect the Bank of Canada to cut rates today and are looking past it.
This Great Graphic was composed on Bloomberg. It shows the 2-year spread (white line) and the US dollar against the Canadian dollar (yellow line). We use two different scales, but the point is not so much how precise they have tracked each other. With two different scales that is misleading.
We argue that the dollar is in its third significant rally since the end of Bretton Woods in 1971. The Reagan dollar rally was driven by the policy mix of tight monetary policy and loose fiscal policy. The G7 effort to stop the dollar’s appreciation at the Plaza Hotel in September 1985 marked the end of the Reagan dollar rally.
The US dollar fell against all of the major and most of the emerging market currencies last week. Risk appetites have been rekindled, and the yen has gone from the best performer in recent weeks to the worst over the past week.
Major equity markets advanced for the third week. The MSCI Emerging Market equity index has rallied more than 15% since the January 21 low, and nearly 12% since the February 11 low. The index finished the week at its best level since January 4.
As systemic anxiety eased, the US dollar got better traction. The dollar-bloc currencies managed to hold their own as cross positions were unwound.
Major bourses posted gains for the second consecutive week. With the recent advance, several markets, including the S&P 500, FTSE and Sweden, China, Korea, and Taiwan are now positive on the month.
The internecine pitch battle between ECB President Draghi and the man who may very well be his successor, Bundesbank President Weidmann opened a new front this week. It is over the future of the 500-euro note.
