As our regular readers know, we have been bullish US dollars for several years now, starting in 2014, on the back of positive economic growth differential, positive nominal rates differentials and positive real interest rates differential.
The strength of the US dollar in the past 5 years ( see chart below) has been reflecting the better efficiency of the US economy, and rightly so.
DXY – US Dollar Index
However, we may now be reaching a turning point as Donald Trump’s Trade wars has killed the global recovery and the US economy is about to turn into recession in 2020. The coming recession will be caused by a sharp fall in the US equity markets, which have an outsized effect on the sentiment of US consumers through their 401-K retirement plans and the wealth effect.
US equities are peaking and will roll into a severe cyclical bear market after the FED meeting on July 31 and that will ultimately take its toll on US consumption.
The US consumer represents 78 % of Americas GDP and the high level of Household Debt amplifies the impact any positive or negative move in asset prices on consumption.
We therefore see the US dollar in its last bout of strength and expect the DXY to trade up to 99 in the coming weeks, but the rise may be actually concentrated on the Asian currency pairs rather than strength of the US dollar against the Japanese Yen and the EUR.
In fact, any turmoil in equity markets will send the Japanese Yen flying and the focus this week will be on the EUR, where the ECB meeting and the expectation of moving back into QE puts the EUR under pressure.
The latest piece of economic news out of Germany is decidedly negative today
Industry in Europe’s largest economy took another battering in July, with a drop in a key measure adding to gloom surrounding multiple corporate profit warnings.
Germany’s factory Purchasing Managers’ Index dropped to 43.1 from 45, the lowest in seven years and below even the most pessimistic forecast in a Bloomberg survey. The reading,
signaling a deeper contraction, means the chance of a recession in Germany continues to rise.
The report is another blow to the economy after a raft of somber comments from some of Germany’s biggest names. Much of the weakness is centered on the auto sector, where firms from
Continental AG to Daimler AG are feeling the pain of flagging global demand as well as the transition to electric vehicles.
But there are also danger signs elsewhere across the corporate landscape, with German chemicals giant BASF SE issuing its own profit warning. Moreover, there’s a risk that a heatwave and low rainfall could restrict barge traffic on the Rhine river, a key artery for business.
More broadly, renewed signs of industrial weakness don’t bode well for hopes that the euro-area economy will bounce back in the second half of 2019.
In a nutshell, economic news could not be worse at the time where the ECB is meeting and the global sentiment has turned resolutely bearish the EUR.
In the past weeks, the EUR fell sharply from 1.14 to 1.113, but the longer term charts are showing a more constructive pattern.
However, With the EUR being already quite oversold, we see the risk of an undershooting but we wouldn’t be surprised to move into a buy the rumors and sell the fact set-up.
So, after the ECB session, we could see a reversal, which effectively could bring us a very important trading bottom in the EUR
An undershooting can re-test/temporary break the April/May bottom at 1.1106, anda subsequent re-break of 1.1106 or 1.1200 we would see as an initially bullish reversal/trigger.