Bank of America nailed the dollar’s comeback — and now recommends 6 ways to figure out what happens next


The US dollar is coming back to life.

It hit a three-year low earlier this year, weighed by comments from Treasury Secretary Steven Mnuchin that indicated a preference for a weaker currency. On Friday, the dollar index was up 4% from its lows of the year hit on February 16, as traders found it increasingly expensive to bet against the dollar’s decline.

“Two weeks ago we argued that FX was dead and that only the USD could bring it back to life,” Athanasios Vamvakidis and Claudio Piron, currency strategists at Bank of America Merrill Lynch, said in a note on Friday.

“We saw some evidence of this in recent days, as the USD has finally started appreciating. It is too early to know if this is the USD rally we were expecting and how far it could go. There was no specific trigger in our view, just an accumulation of good news that should had [sic] led to a stronger USD well before, and a short market position.”

For traders looking for a specific recommendation, BAML suggests selling the euro against the dollar. Their trade, entered at 1.2378, was initiated on April 16 with a target of 1.15. The EUR/USD pair traded at 1.2077 at 10:17 a.m. ET on Friday.

Risks that this trade goes sour include US policy uncertainty and trade protectionism, Vamvakidis and Piron said. They also have six things that investors should watch to determine whether the dollar will continue its ascent, and how high it would go.

  1. US data, especially on inflation: They observed that economic data has been strong this year, even with the residual seasonality effects that tend to weigh on growth in the first quarter. On Friday, the first estimate of Q1 gross domestic product came in at 2.3%, down from the prior quarter on weaker consumer spending, but stronger than economists had forecast.
  2. The Federal Reserve: The Federal Reserve’s dot plot reveals that traders’ estimates for interest rates and the timing of the next recession are less bullish. The question for Vamvakidis and Piron is whether markets catch up to the Fed if the data remain strong.
  3. Profit repatriation: Under the Tax Cuts and Jobs Act, multinationals can make a one-off payment on profits socked away overseas — 15.5% on cash holdings and 8% on illiquid investments — versus a 35% tax under the old policy. It’s still too early to know whether multinationals are returning cash held overseas following the passage of the Tax Cuts and Jobs Act. But once repatriation starts, BAML expects it to be bullish for the dollar as billions in foreign currencies are converted.
  4. Trade: The strategists expect a deal on NAFTA and compromises on the US’s trade friction with China.
  5. Flows: “If we are right about imminent trade deals, we would expect central bank USD selling to slow back to the long-term trend, allowing the USD to rally in response to strong fundamentals,” Vamvakidis and Piron said. They observed that hedge-fund dollar buying has increased in recent weeks, but has been offset by central bank selling.
  6. The eurozone: What to watch here is the economic data, Italy’s efforts to form a coalition government that could threaten its relationship with the bloc, and financial reforms.
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