Tuesday, May 19, 2020

How much more can the dollar fall amid news for a potential vaccine?

Tags
  • Dollar
  • Federal Reserve
  • FOMC minutes

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Analysts’ Pick: How much more can the dollar fall amid news for a potential vaccine?

  • Powell’s testimony before the US Senate Banking Committee tonight will likely reiterate his statements over the past week
  • FOMC’s minutes should continue to signal that negative rates are unlikely in the US and that a gradual recovery instead of a sharp recovery should be expected
  • US-China relations are likely to continue to escalate, but downsides may be limited as both countries battle the aftermath of the Covid-19 pandemic
  • The effects of the positive data from Moderna on a potential vaccine may only be temporary and is likely to ease as it is still only in its initial phase of testing
  • The dollar may continue to fall today but may have room to rebound at Powell’s testimony later today

Fed Chair Jerome Powell is set to testify in front of the US Senate Banking Committee later today at 10pm (GMT +8), alongside US Treasury Secretary Steven Mnuchin. His testimony is likely to continue to reiterate his statements since the previous week.

At a web conference hosted by the Peterson Institute for International Economics last week, Powell echoed other Fed officials' statements earlier that week saying that the FOMC's view on negative rates has not changed. Interestingly enough, speculation over the past week for negative rate in the US has mostly eased. This can be seen by the Fed Fund futures shifting downwards away from trading above the 100.00 mark (above which implies that traders are expecting negative rates). While Powell's comments likely helped, positive data from Moderna in the initial testing phase of its experimental vaccine for the novel coronavirus also likely contributed to the easing of speculation for negative rates in the US. In addition, as Powell is expected to reiterate his stance in front of Congress later today, the outlook for the dollar is likely to continue to tilt towards the downside.

Speculation for negative rates in the US eased after Powell’s comments and news of a potential vaccine

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The FOMC's monetary policy minutes that will be released on Thursday at 2am (GMT +8) is likely to express the unanimous view of committee members in providing support for the economy via unconventional monetary policy tools. Negative rates are unlikely to be one of the considerations however, as Fed officials have mostly implied that negative interest rates will be ineffective in this type of crisis. Also, Powell's statement on Monday in an interview also states that interest rates will remain near zero for an extended period of time. This should provide some slight upward pressure on the greenback later in the week. The meeting minutes should also show FOMC members' outlook for the US economy skewed towards the downside, with a gradual recovery and not a sharp one. But the financial market has likely already priced in most of this information.

Fed Fund futures imply that the market sees no movement in interest rates at the next monetary policy meeting

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However, escalating tension in US-China relations may put some upward pressure on the dollar. In the last week, US officials have been more vocal on the US-China trade war front and the origin of the Covid-19 pandemic in China. Most recently, the US restricted global chip supplies to Huawei Technologies on Friday, further escalating tension between the two countries. While the phase-one US-China trade deal is still in place, it is unlikely that China will be able to meet its targets amid the global Covid-19 crisis. The options for the US however, seems to imply that the US is unlikely to revert away from the agreement and increase tariffs on Chinese imports into the US since it will likely cause a deeper recession and depress stock prices further. China is unlikely to restart the trade war as well as it would probably want to focus resources on lifting up its economy after the lockdown across multiple cities. Thus, while tensions are likely to continue to escalate, the downside for the worst-case scenario should be limited.

Sharp declines across multiple economic data sets in the US implies that additional tariffs may be unlikely

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As for the positive data from drug maker Moderna's experimental vaccine, the surge in risk-on sentiment may only be temporary. Stock prices surged while safe haven assets fell on the news of a potential vaccine. But it is important to note that while the experimental drug has shown to have no major safety concerns and may show potential to be a viable vaccine to the novel coronavirus, it still in its initial phase of testing. The company only expects the third phase of testing to be conducted soonest in July 2020 before the submission to regulatory bodies for approval before finally being able to mass produce the vaccine. This means that there may still be a period of time before a vaccine is even ready for distribution. The spike in asset prices does however give us an idea of what to expect (i.e. to take advantage of possible mispricing in the market) if more good news comes out regarding a potential vaccine. In the short-term however, it implies that the dollar's sharp decline on Tuesday will likely be short-lived and should be expected to ease, especially as risks continue to skew the dollar towards the upside.

The dollar gained as US-China tensions escalated through last week

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As a result, the dollar may have more room to fall, as the London stock market opens today and traders continue to price in the effects of a potential vaccine, possibly inching past 99.39's level. Then there may be some upside for the greenback to rebound slightly later today at Powell's testimony before the US Senate, possibly pushing the Dollar Index back towards 99.51's level, or an upside potential of approximately 0.11% since a potential vaccine should be fully reflected in prices by that point of time. The Dollar Index may then face more upside pressure later in the week if risk sentiment starts to return on the release of the FOMC's meeting minutes as well as the possible escalation in US-China tensions, possibly pushing the index higher towards 99.71's level.

Technical Analysis:

DXY

Bears have gained momentum with the dollar falling thanks to hope for a potential vaccine against the novel coronavirus and is likely to continue over the next hours as volatility will probably extend into the evening with London only just entering the market. DXY should as a result be able to retest and possibly the 23.6% Fibonacci retracement level. But it looks like to only inch slightly lower towards 99.31 before a possible rebound as bulls start to charge ahead as short positions may start to be closed at this point. Powell’s speech may also increase risk sentiment in the financial market since the sharp drop was likely only a temporary one resulting from the possibility of a vaccine as the positive data was only from the initial phase of testing. DXY may rise to hit 99.51’s level as a result later tonight, and possibly return to 99.71’s level over the week if US-China tension continues to escalate, giving the necessary push for bulls to sustain some momentum moving forward.

Support: 99.31 / 99. 14 / 99.08

Resistance: 99.51 / 99.62 / 99.71

DXY Chart (H4)

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