MUFG notes that the US dollar has weakened further this week and expects losses to continue in the near term; “The US dollar is pulling back with some key developments indicating further weakness in the near term.
The Euro / Dollar (EUR / USD) exchange rate peaked at 4 month highs above 1.2260 before correcting slightly.
According to MUFG, the gains for the Chinese yuan are a key element in both the decline in the dollar seen so far and the expectation of further losses. The offshore exchange rate between the dollar and the yuan (USD / CNH) fell below 6.40.
The bank points out that a stronger Chinese currency will help ease the domestic inflationary impact of rising commodity prices in the economy. The yuan’s gains will also have important implications for the dollar.
“But today’s decision, while well managed and in part reflects the development of the dollar more broadly, may also fuel broader downward pressure on the dollar.”
Hedge funds hunt for new dollar losses
Nomura also notes that risk appetite is expected to strengthen in the near term, which will tend to undermine the support of the US currency for defensive reasons. Nomura also notes that hedge funds have increased their dollar sales in search of higher returns; “Global hedge macro funds are selling US dollars again in their quest for yield.”
In this context, the dollar will tend to remain under pressure if real interest rates remain extremely low. TD Securities Notes; “Without a major real shake-up, the catalyst for a lasting dollar reversal will be lacking.”
ECB measured relief from yuan gains
The MUFG also notes that the appreciation of the yuan would have a significant impact on other global central banks, including the ECB.
A stronger yuan would ease upward pressure on the euro trade-weighted index and also allay the ECB’s concerns about tighter financial conditions. A firm yuan would also help protect German competitiveness in the key Chinese market.
“This USD / CNY breakout is therefore significant and opens up the potential for broader USD weakness and at the margin means a little less ECB concern over the appreciation of the Euro.
A stronger Chinese currency would therefore increase the tolerance for EUR / USD gains.