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What the Dollar and Emerging Market Currencies Can Tell Us About the Market

What the Dollar and Emerging Market Currencies Can Tell Us About the Market

John Kicklighter, Chief Strategist

Talking Points:

  • The Dollar has won an impressive month of progress and the past day's performance was impressive itself
  • There are various themes that can prompt US - and broad markets - including risk trends, monetary policy and basic speculation
  • When we consider the aggressive move for pairs like USDBRL, USDINR, USDZAR, USDTRY; we can see see a full market picture

See how retail traders are positioning in the FX majors, indices, gold and oil intraday using the DailyFX speculative positioning data on the sentiment page.

The Dollar's Ubiquity

The world's most liquid currency - and arguably its most widely traded instrument overall - the US dollar can wield extreme influence over the broader financial markets and more economically-atuned commodities. When there is a motivated bullish or bearish drive behind the Greenback, it can charge even benchmark pairs like the EUR/USD and USD/JPY such that the impact of both counter-currencies spread through the Euro and Yen crosses. A substantial change in currency value can also materially alter the cost of critical commodities like Gold and oil with impressive implications for output and GDP. Then there is even its influence on a structural basis where a swing can translate into Treasuries as a global haven asset or it can in turn lead to a remarkable shift in political/trade policy. This currency can single-handedly start and stop global trends. Yet, what motivates this movement matters just as much - if not more - than the immediate degree of trend as it can signal deeper current changes that spur lasting trends or more systemic shifts.

What the Dollar and Emerging Market Currencies Can Tell Us About the Market

Common Drivers for the Dollar

There are thousands of reasons that the Dollar is sold or bought, but there are general themes that more capital tends to follow such that trends develop over time. Recently, we have seen three general motivations vie for influence over the benchmark. The currency's role as a safe haven, its evolving monetary policy advantage and general speculative repositioning have all exerted significant influence on direction and pace over the past weeks and months. Starting from the more recent, we have speculative rebalancing. Where traders had built up a record net long EUR/USD futures position and a five-year extreme in net aggregate Dollar interest, there is a pull to rebalance with short covering offering an inherent bid. The Fed's monetary policy advantage is another big driver over the past years, and one that has benefit the currency more potently recently with its ECB, BoE, BoJ counterparts retreating from normalization. Then there is the safe haven status the Dollar maintains whether it is of value or not. This has not been a key driver as of late owing to the lack of conviction in sentiment; but when triggered, its influence is without rival.

What the Dollar and Emerging Market Currencies Can Tell Us About the Market

Comparing Performance to Evaluate Motivation - For Trend and Momentum Purposes

If we were trying to evaluate what was driving the Dollar and/or motivating the broader market, we can look at different facets of price action. If pure speculative rebalancing were responsible for the Dollar's drive, we would expect a more productive gain of traction across the major counterparts; but pairs like GBP/USD and AUD/USD have marked little progress. If the motivation behind the market was to seek out monetary policy advantage, there would far more robust moves for the EUR/USD, GBP/USD and USD/JPY where the counterparts are distinctly dovish to the Fed's hawkishness with their slide down the policy scale. And, if there was a safe haven drive, risk assets like global indices would be under heavy selling pressure.

What the Dollar and Emerging Market Currencies Can Tell Us About the Market

What the Dollar's Charge Against Emerging Markets Can Tell Us

This past session, the Dollar registered noteable strength on a broad basis which can negate a number of possible factors for what is influencing markets. The EUR/USD drop hasn't forged a critical break to extend its 2018 lows, so that could open the possiblity that monetary policy speculation is catering to the outlook but not redefining trend. However, when we add in the drive for the 10-year Treasury yield to a fresh 7 year high; there is certainly further bolster for this theme at least being a motivation. With US equities - as a benchmark for sentimment - slipping, there is an additional signal of mild risk aversion (which usually is seen as conflicting with monetary policy speculation). As unusual as this mix may seem, it finds a stronger advocate when we consider the Dollar's performance to the greater intensity against the emerging market currencies. Paired with the Mexican peso, South African rand, Turkish lira, Brazilian real, Indian rupee and others; we see a more pressing but also lasting bullish move. Add to that political risks on trade fallout and this could be one of the most at-risk asset class (emerging market currencies) with this confluence of fundamental themes. We discuss contrasting the Dollar and emerging markets currencies for a deeper understanding of the market in today's Quick Take video.

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