Thursday, May 28, 2020

Will optimism for an economic recovery be enough to keep the dollar from rising?

Tags
  • China
  • Dollar
  • US Durable Goods Orders
  • DXY

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Analysts’ Pick: Will optimism for an economic recovery be enough to keep the dollar from rising?

  • Headline durable goods orders may be inflated thanks to a slight increase in net orders from Boeing in April and seasonal adjustments
  • US-China tensions look likely to continue to escalate
  • High optimism may result in greater upside potential for the dollar as risks are likely not fully priced into the financial markets

The greenback should continue to experience more volatility this week thanks to upcoming economic data as well as pressure from increasing tension between the US and China. GDP and durable goods orders will be released today at 8.30pm (GMT +8) but is unlikely to result in strong movements for the dollar.

The second estimate for Q1's GDP should show some minor adjustments as a result of delayed data in the first estimate, but the extent of the decline in personal consumption is unlikely to change. The dollar however, should not be expected to be driven by the GDP dataset, since it does not reflect the easing of lockdown restrictions since early May.

Durable goods orders for April may have some room for surprise however as a result of over pessimism in economists’ estimates. Economic data for April was mostly better-than-expectations, probably thanks to the high level of uncertainty and unprecedented level of fiscal and monetary stimulus. But while durable goods orders are likely to experience another sharp contraction in April since most businesses would not be investing in new projects at the moment, it may drop less-than-expected. The biggest dent should continue to come from declining demand for transport, as lockdowns that started at the end in March would imply a decline in demand for international travel and domestic transport. But the headline figure may be inflated as Bloomberg reported Boeing's net orders including cancellations to be at -108 for April, from -119 for March. Seasonal adjustments may also help inflate figures from the dataset further and as a result maybe be closer to March's figure of -14.7% instead of economists' estimates for -19.1%.

Falling gas prices and low auto sales in April signal that transport is likely to continue to weigh on headline durable goods orders for April

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The highlight for the week however, should be upside pressure for the dollar as a result of safe haven demand. Tension between the US and China is escalating, evident from moves made by both countries over the past weeks. Most recently, US Secretary of State Michael Pompeo has announced that the US can no longer be certain that Hong Kong is politically autonomous from China, which would effectively allow the US a wide range of sanctions on Hong Kong. The announcement implies that geopolitical risks has risen, with the US signalling that it might possibly impose sanctions on Hong Kong in order to pressure China on a different front from the US-China phase one trade agreement. While both countries are unlikely to outright walk away from the phase one agreement amid anticipated economic contractions in the short-term, tensions have more room to escalate which would implicitly mean that a phase two agreement is much further away than before. This is likely even more true with the Trump administration putting more pressure on China in recent weeks, likely to pressure China into complying with the phase one trade agreement despite unforeseen circumstances due to the Covid-19 pandemic, as well as ahead of the November presidential elections in the US.

A rapid decline in the VIX index and rising equity prices imply that risk aversion has eased

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Lifting of Covid-19 restrictions has put downward pressure on the dollar over the past two weeks but it also presents upside potential for the greenback in the medium-term. More states in the US has started to reopen their economies, fuelling optimism for an economic recovery. But with risk aversion already seen to have been largely easing over the past two weeks in the financial market, it increases the likelihood that we may see the dollar rise in the short-term as risk of new cases of the Covid-19 pandemic increase. As reference, South Korea is currently experiencing its biggest spike in new Covid-19 cases after two months, with the country reporting 79 new cases (while a small absolute number, it is about double from a day earlier), signalling that there is a possibility for the US to experience a spike in new cases as well, which is likely to weigh on investor sentiment.

Contrast between confirmed cases of Covid-19 in the US and Italy suggests that it may be premature for the US to ease restrictions

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As a result, we see the dollar rising in the short-term to medium-term as US-China tensions are likely to escalate further. The market has also largely discounted this and is rather optimistic, evidently from the sharp increase in equity prices over the past couple of weeks. Risks imply that we may see the Dollar Index climbing over the short-to-medium-term as a result, possibly towards to 99.81’s level.

Technical Analysis:

DXY

The Dollar Index is trading close to its 50% Fibonacci retracement level, signalling that we may see another uptick towards the 61.8% retracement level in the short-term. With a strong support at 98.82’s level, this looks to be the case as the greenback bulls are currently trying to break the moving average resistance at 99.00. With geopolitical risk likely to continue to rise this week, we think an uptick towards the 61.8% retracement level at 99.81 is likely as well. If, however, the bears manage to break 50% retracement level, they will likely push the dollar lower and retest the 98.29 support to possibly create a new one-month low. Positive news of a vaccine or treatment for the Covid-19 virus is likely to help fuel this selloff.

Support: 98.81 / 98.56 / 98.29

Resistance: 99.26 / 99.48 / 99.69

DXY Chart (H4)

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