U.S. Goes For Worst-case Scenario For The Dollar

Asian markets are losing again on Friday and are on track for their worst monthly decline since last March. However, we do note a marked improvement in sentiment compared to the start of the week. Friday's 0.8% drop in Asian indices on the MSCI Asia Pacific is quite understandable due to the pull into the dollar and the pressure on risky assets later in the month and week, which could stretch into the end of the day.

At the same time, the news backdrop so far remains on the side of a weaker dollar. Macroeconomic data failed to surprise. The number of people receiving unemployment benefits in the USA stagnates again after the momentum of decline at the beginning of the second quarter. The number of initial claims over the last two weeks is again over 400K.
 
According to the provisional US GDP estimates for the second quarter, the economy was 0.5% above its pre-pandemic peak. However, the growth rate last quarter did not accelerate as economists on average expected. Announced growth was 6.5% compared to 6.3% the previous quarter.

The data generally indicates a relatively high economic growth rate. Still, the stagnating labour market is a cause for caution and does not pave the way for a normalisation of monetary policy. At the same time, GDP is recovering quite rapidly to its pre-crisis trajectory.

This appears like a worst-case scenario for the dollar as it would force the Fed to take a wait-and-see approach, turning a blind eye to high inflation and continuing to feed the economy with easy money. Part of this liquidity is going into the markets, causing a further rise in the prices of listed assets.

We should not forget the fundamental reason for the dollar's weakening: High inflation is eating away at its purchasing power. The two-year US bond now yields 0.2% in a situation with 5.4% inflation and price growth of 3.4% in 2021 and 2.1% in 2022.
 
Fundamentally, the dollar is only sustained by its reserve currency status and a high degree of uncertainty in a world where it isn't easy to find an alternative right now. Each region has its own set of doubts, from fears of stagnation in Europe to threats of market capitalism in China.

However, investors should remember that the British pound was once the main reserve currency, with its strength based on power in the colonies. But that did not stop the pound from declining in the middle of the century.

The UK of half a century ago and the US now have in common their reserve currency status and the high debt burden. A stagnant labour market will tie the hands of the Fed in normalising monetary policy.

The FxPro Analyst Team