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US Dollar in Danger of Further Losses – Here are the Key Risks

US Dollar in Danger of Further Losses – Here are the Key Risks

David Rodriguez, Head of Product

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Fundamental Forecast for Dollar: Neutral

The US Dollar tumbled for the second straight week against the Japanese Yen and other major counterparts in a volatile week for global markets. Yet upbeat economic data suggests that the move has been overdone, and it seems fairly clear that broader market turmoil remains the biggest driver of currency moves. A US market holiday on Monday makes continued near-term volatility less likely, but the true fireworks will likely come on Sunday night when Chinese traders return from Lunar New Year holidays.

Sharp declines in China’s stock markets acted as catalyst for the recent stretch of global financial market turmoil. China’s Shanghai/Shenzhen CSI 300 Index has nonetheless been spared from the past week of stock market sell-offs as domestic markets remained closed for New Year celebrations. Big moves out of the world’s second-largest financial market could once again set the pace for the rest of the world, and the key question becomes whether further market turbulence will send the Dollar to fresh lows.

FX traders could continue to sell the US Dollar—particularly against the Japanese Yen—if we see continued sell-offs in the S&P 500 and broader ‘risk’. The S&P itself is on its worst losing streak since the heights of the global financial crisis in 2008/2009. At that time any sell-offs in global markets coincided with US Dollar and Yen appreciation, but more recent stock market tumbles have actually produced Dollar losses.

This isn’t the first time this has happened—we saw much the same dynamic in August of last year as many believed the Euro had suddenly become a safe-haven currency. And indeed the US Dollar will likely remain correlated to moves in ‘risk’ for the foreseeable future. Yet traditional fundamental drivers of currency moves suggest that the USD could stage a comeback once one-sided speculative positions are fully unwound.

Any surprises out of upcoming US CPI inflation figures or the release of minutes from the US Federal Reserve’s January policy meeting could thus force important swings in US Dollar pairs. The Fed famously ended its zero interest rate policy at its December meeting and decided to keep rates on hold when it met through late January. In keeping rates unchanged, the FOMC statement showed officials feared sudden financial market turmoil could hurt growth prospects. Fed Chair Yellen spoke to such fears in her testimony to the US Legislature. Yet it will be important to see the extent to which the broader Federal Open Market Committee fears such risks. Any especially dovish commentary could force further US Dollar losses.

Volatility risks remain high on what promises to be another big week for the Dollar and broader markets. Whether or not the Greenback finally stages a recovery may ultimately depend on price action out of China and late-week Fed commentary.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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