Dollar rest is a sham: waiting for the price shock

The euro-dollar exchange rate has ended up in very calm waters over the past few months. In the past, however, such a lull has all too often been followed by a major storm.

The exchange rate fluctuations of the British pound demanded almost all of the attention on the foreign exchange market. This is of course mainly due to the unrest about a possible hard Brexit. On the other hand, the striking calm in the other parts of the currency world also played a role. Against the euro, the US currency has been moving in the narrow range of $1,118 to $1,155 for more than half a year. However, behind the apparently calm course of prices, there is a shaky balance hidden.

The value of a currency is often strongly influenced by inflation expectations and central bank policies. Based on that, you would expect the dollar to be a lot higher. The American short-term interest rate (2,5%) compares favorably with that of the European Central Bank (0%). When it came to savings accounts, the choice was made quickly. Another argument for the strong dollar are the signals that European growth is weakening.

Fed under pressure
While a European interest rate hike is still a long way off, the chance of a rate cut in the United States appears to be increasing. In the economic field there is little reason for this; the labor market is tight (with an unemployment rate of less than 4%), while wages are increasing by more than 3% on average. However, US President Donald Trump has been increasing pressure on the Fed for some time now. Its economic boost would suit him well (with a view to next year's presidential elections).

Trump is reportedly even considering firing Fed chairman Jerome Powell. Uncertainty over the bank's independence is prompting China, Russia and other countries to convert their dollar reserves into gold and other currencies. An unstable balance has emerged between this dollar outflow on the one hand and the interest rate differential on the other. Which way will the balance tip in the future?

The weakness of the euro
There is a good chance that a completely different event will be the deciding factor. The populist parties are heading for a big win in the European elections. The uncertainty about new relations in the European Parliament can also put pressure on the euro. Moreover, in a few months it will be time to draw up the budget plans again. There is then a good chance that, just like last year, this will lead to growing divisions within Europe.

Finally, the risk of Brexit has not (yet) completely disappeared from the radar. When the euro-dollar rate moves towards 1, it will be due to the weakness of the euro rather than the strength of the US currency.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.