US Dollar: Will the break-down be the beginning of a bear market?

We have seen that since the outbreak of the epidemic in Europe and the United States, the US dollar has shown a sharp rise and fall and finally gradually converged. The decline is driven by the downward impact of demand expectations and the spread spread caused by the expansion of the epidemic. Its rise is under the pressure of the epidemic. Driven by global demand for hedging. We can find this trajectory quite clearly in light of the events that occurred at each time period against the trend of the US dollar. When the momentum of supporting the US dollar and suppressing the US dollar reached equilibrium in the end of March, the Fed’s loosening of the expansion of the table, and the need for hedging The trend showed a state of convergence and turbulence, and when the ethnic protest march broke out in the United States at the end of May, the fragile balance was broken.

Since the outbreak of racial protest marches, the support for Trump’s polls has declined, and various contradictions brought about by the unemployment economy’s downturn have erupted together, which has comprehensively produced a motivation to question the dollar’s safe-haven credit. This will break the fragile balance of the US dollar that was maintained before, making the end of May the beginning of the fall of the US dollar.

Figure: The US dollar index’s most pessimistic bottom of the epidemic at the end of February and the fragile balance point after the race is considered to be below

Data source: Refinitiv Eikon

Figure: After the outbreak of ethnic demonstrations at the end of May, Trump’s approval rating dropped significantly

Data Sources:

The main driving force of the current decline of the US dollar: loosening of expansion of the table and narrowing of the spread of virtue
From the internal logic, the endogenous depreciation momentum of the US dollar index has always existed, which is why we have been emphasizing the long-term appreciation of the US dollar and the mid-to-short-term deep adjustment in our previous articles. It’s just that the dollar hasn’t fallen because the demand for hedging has prevented the dollar from showing a decline. In fact, this kind of power is not understood by everyone. The simple Fed’s excessive expansion of the table is loose, but the continued decline of the US-German spread. Because the dollar index or any other currency pair is essentially the ratio of the currencies of the two countries, rather than the absolute value, the dollar index is the ratio of the basket of currencies. Therefore, we observe that the Fed’s room for easing is actually greater than that of the European Central Bank, which has exhausted all its resources. From the comparison between the ECB interest rate resolution and the Fed’s interest rate resolution, we can see that the ECB only has quantitative easing, while the Fed is cutting interest rates to zero + unlimited quantification. Looseness (this is because the Fed has undergone a round of interest rate hikes to bring the monetary policy space back to a high level), this comparison can clearly see why the U.S.-German spread is down sharply, thus giving the dollar a clear downward momentum. This motivation It has been in existence since the end of February, and it is only now that it has begun to show its downward force.

From this we can see that after the outbreak of the outbreak, the dollar’s ​​previous low of about 94 was actually anticipating potential currency easing. In fact, the current driving force is that this momentum is working, and we observe the decline of the US-German spread. The trend is still there, but the spread is basically stable, that is to say, there is no stronger momentum to bear the dollar, so our judgment is that this wave of dollar so-called entry into the bear market does not exist, just the long-lasting momentum is released, and now it has To the end of releasing power. Unless the United States completely loses the credibility of the safe-haven currency due to the outbreak of the epidemic or domestic unrest, the dollar has no incentive to fall for a long time.

Fed’s monetary policy options-possible changes to YYC
The Fed’s YYC policy has not been confirmed, but what can be confirmed is that this probability is high.

First of all, we have to see that the expectation of YYC (YieldCurve Control Yield Curve Control) is itself a reluctance to continue to quantify easing, or that easing has come to an end, and in fact unlimited easing has no higher options. . So what remains is the controversial so-called negative interest rate. I believe the Fed will not blindly follow the footsteps of the European Central Bank and the Bank of Japan, otherwise there will be no previous round of interest rate hikes and constant statements by Fed officials-negative interest rates will not be implemented.

Chart: The U.S.-German spread is still a downward trend in interest rate resolution, showing that the fundamental logic of the US dollar bearish exists but is basically stable

Data source: Refinitiv Eikon

Chart: Degree of change in the term structure of US debt

Data source: Refinitiv Eikon

Secondly, we should see that the essence of YYC is to lower the remote interest rate and make the yield curve flatter. This is a bit similar to the reverse operation carried out by the Fed after 08. It does not provide more liquidity supply, but only adjusts the maturity. structure. This may cause the liquidity of the US dollar not to change much at the same time, while the long-end interest rate remains low, thereby making the US dollar continue to fluctuate at a low level. From the graph below, we can see that the U.S. Treasury yield curve has shifted downwards and the structure has become steeper than before the outbreak (green curve), and the curve structure after the outbreak of the European and American outbreak of No. 2.21 (blue curve) has begun to stabilize. The rebound means that the market’s most pessimistic expectations have gradually passed, but after comparing the market’s expectation of YYC (purple curve) after the end of May, the yield curve (current yellow curve) is flatter.

Finally, we see that the growth of the Fed’s balance sheet has been gradually slowing, and the release of incremental liquidity is at the end. In order not to cause market panic about the future, we have repeatedly guaranteed that it will not be less than 120 billion US dollars per month. Release scale.

The Fed’s interest rate resolution impact
The Federal Reserve’s interest rate resolution on June 10th interpreted the market response as: Powell’s continued doves, low interest rates will stabilize until the end of 2022, the economy is expected to recover by the end of 2020, and the market interprets that the Fed will be more lenient. Interest rates are expected to fall further. But we pay attention to observe that after the meeting, the U.S.-German spread did not continue to decline, and the exchange rate of the US dollar also began to stabilize. The market believes that the expectation of continued interest rate decline has been price in, and no unexpected changes have occurred. Therefore, we judge that the US dollar is only a pattern of continued weakness in the medium term, unless the epidemic breaks out again or there is a significant decline in the credit base of the US dollar.

Impact on non-US currencies
The exchange rate of the US dollar is directly related to the exchange rate of all non-US currencies. This may also explain the reasons why the Brazilian real, Indian rupee, and Argentine peso suddenly began to appreciate recently. Because this also directly affects the supply and price changes of related commodities.

At the same time, we also need to see the impact on gold and crude oil: in the short term, it does bring momentum for gold and crude oil to continue to rise, but it needs to be clear that usually only the long-term view of the dollar and crude oil and gold are negatively correlated. Relationship, and in a short period of time, gold and crude oil tend to follow their own endogenous logic. We have already mentioned that the decline of the dollar is not a long-term trend, but a medium-term adjustment. Therefore, the trend of gold and crude oil depends on internal logic.

Finally, we should also see that the renminbi is also a non-US currency, and its currency value will also be directly affected by the US dollar. Simply put, the short-term renminbi exchange rate will have a slight appreciation momentum. Since its logic is far more complicated than that of emerging market currencies, we will elaborate more specifically later.