This week, the dollar broke free from its spiral of weakness and recorded a strong jump in value. Investor sentiment was very negative, reinforcing the magnitude of the reaction.
The obvious questions in such a setup are whether we see a correction of the negative stance towards the dollar or a breakdown of the downtrend? We are closer to the opinion that it is still a corrective bounce. To change the trend, we would need macroeconomic data bringing the Federal Reserve closer to the early start of tapering its asset purchases. First of all, the recovery of the labour market from a pandemic slump would have to accelerate. Secondly, signs that inflation is not about to start slowing down could bring the Fed closer to such a step.
The EUR/USD pair may found support at 1.19
The dollar is having its best week against the main currencies since September. The EUR/USD rallied from 1.2150 to 1.19, a zone that is consistent with the average value of the exchange rate over the last year. However, we should be aware that the Federal Reserve has made a big move towards the normalization of the policy. In this field, it is currently ahead of the European Central Bank by (at least) half a step. The contrast in perspectives was underlined by yesterday's words of the ECB's chief economist, Philip Lane, who announced that in September, it may still be too early to consider abandoning the crisis instruments and pandemic asset purchases.
What does this mean for the currency market? If the dollar's rebound loses momentum, there should be no way for it to fully erase against the euro, franc and yen, i.e. currencies for which the monetary policy is a burden. In particular, those currencies whose monetary authorities are closer to tightening (e.g. the Norwegian krone, and in the EM basket, the forint and the Czech koruna) will perform better.