The long USD trade continues to be the talk du jour. It has rallied around 10% vs. the EUR and 5% to 8% vs. other developed and emerging market currencies since July this year. This trade has not only been driven by the differing interest rate prospects across the respective regions, but also by better economic growth seen in the US relatively.
The September FOMC statement showed that the Committe had not changed its forward guidance indicating fed funds target range will likely remain unchanged “for a considerable time after the asset purchase program ends.” However what rattled the FX markets and the USD specifically was the Summary of Economic Projections that showed slightly higher dots for 2015, 2016 and 2017, suggesting the potential for slightly higher rates going forward.
Meanwhile the European Central Bank confirmed its loose accommodative monetary policy stance at its September press conference. Draghi stated ECB goals to steer its balance sheet towards levels seen at end 2012 (close to 3 trillion euros). This implies roughly a 1 trillion euro increase in the size of their balance sheet.
On this side of the pond, the UK has faced its own share of shenanigans with the uncertainty (or reality check rather) going into the Scottish independence vote throwing a spanner in the long GBP trade. GBP had long been trading rich vs. its USD counterpart, and the vote itself caused people to re-evaluate the risk reward surrounding that stance. In addition, UK BoE Governor Carney reitereated that the first rate hike is still on the cards for early Spring and that the pace of interest rate hikes will be slower and more gradual.
Taking all this into consideration, the USD had no choice but to move one way….higher!
We are all aware what a strong USD does to Commodities. Rightly so since July, Copper has fallen 9%, Aluminum down 9%, Oil down 15%, and Iron ore fell another 20% just in the last two months resulting in a net 41% fall year to date.
Of course it is easy to blame the USD rally for this collapse in Commodities. But what is important to realize is that most of these Commodities have been weak all year and were at best trading in a range bound market. The USD rally only helped catalyze the trend evidenced in physical markets. These markets have been facing prospects of bloated supply combined with weak demand for some time. Prices are just moving more in sync with their fundamentals and in some cases closer to their marginal cost of production levels. In a nutshell, prices are reaching a point of equilibrium where demand meets supply. One must ask whether fundamentals still warrant holding a short position here.
Doesn’t feel lonely anymore being a bear, does it?
