(Reuters) – A rally in the U.S. dollar has investors looking at a broad range of factors — from global COVID-19 infections to yield gaps — to determine whether the greenback will continue appreciating.
The dollar is up 4% from its lows of 2021 and is among the world’s best performing currencies this year, boosted by last month’s hawkish shift from the Federal Reserve, burgeoning inflation and safe-haven demand driven by COVID-19 worries.
Because of the dollar’s central role in the global financial system, its moves ripple out towards a broad range of asset classes and are closely watched by investors.
For the United States, a period of sustained dollar strength would be a double-edged sword, helping tamp down inflation by increasing the currency’s buying power while denting the balance sheets of exporters by making their products less competitive abroad.
On the other hand, dollar strength would continue pushing down currencies such as the euro and British pound, potentially giving a boost to the recoveries in those countries.
Here are several things investors are watching to determine the dollar’s trajectory.
GRAPHIC: Delta dominance – https://graphics.reuters.com/USA-MARKETS/DOLLAR/znvnedbnbpl/chart.png
THE DELTA VARIANT
Some investors believe the dollar – a popular safe haven during uncertain times – will rise if the Delta variant of COVID-19 spreads and risk aversion grows in markets.
COVID worries have already helped the dollar notch gains against the currencies of countries where the Delta variant is proliferating, including the Australian dollar and the British pound. Those gains could fade if coronavirus concerns ebb in coming months, however.
“We’re seeing a lot of risk factors and uncertainty across assets, said Simon Harvey, senior FX market analyst at Monex Europe. “Investors are looking at all these and saying that they’re going to find refuge in the dollar.”
GRAPHIC: Global composite PMIs – https://fingfx.thomsonreuters.com/gfx/mkt/gdpzyrqbwvw/Pasted%20image%201626975937207.png
While some investors are concerned the U.S. rebound is slowing, it still outpaces the bounce seen in Europe and other regions.
That gap in growth, illustrated by such metrics as stronger manufacturing sector growth and inflation, is among the factors putting upward pressure on the dollar, said Morgan Stanley’s James Lord in a recent podcast.
“There is a case still for the dollar to strengthen as we do see more divergence,” he said.
GRAPHIC: Yield spread – https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnrnmavq/Pasted%20image%201626898123514.png
Though Treasury yields have recently slid, the gap between real yields on U.S. government debt and some foreign bonds has widened, raising the allure of dollar-denominated assets. Real yields represent the cost of borrowing after stripping out inflation effects.
The spread between the real yield on 10-year Treasury Inflation Protected Securities at “constant maturity” and those on their German counterpart, for instance, stood at 72 basis points late Thursday, up from 63 basis points two months ago.
GRAPHIC: Stopped short – https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnrgzzvq/Pasted%20image%201626976483803.png
Speculators’ net short positions on the U.S. dollar fell to their lowest level since March 2020 last week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on July 16.
“The most crowded trade in the world through the first quarter was the short dollar. We had, unquestionably, a squeeze on the way back,” said Karl Schamotta, chief market strategist at Cambridge Global Payments in Toronto.
The dwindling bearish sentiment could mean there is less fuel for further dollar gains. At the same time, “the dollar and other currencies do tend to overshoot when they are correcting, in both directions,” Schamotta said.
GRAPHIC: The “golden cross” – https://fingfx.thomsonreuters.com/gfx/mkt/gdpzyrqawvw/Pasted%20image%201626987284293.png
The Dollar Index’s 50-day moving average is close to crossing above its 200-day moving average and forming a chart pattern known as a “Golden Cross” that is seen as a bullish signal by those who follow technical analysis.
A Golden Cross “could herald another leg higher for the greenback,” said Joe Manimbo, senior market analyst at Western Union Business Solutions.
(Reporting by Saqib Iqbal Ahmed; editing by Ira Iosebashvili and Richard Pullin)