Goldman: Dollar Bull Run Is Just Getting Started

blogs.barrons.com

By Shuli Ren

After a “pristine” jobs report last Friday, we can expect the U.S. dollar to break out and the euro to reach parity and beyond by the end of this year, according to Goldman Sachs.

The U.S. dollar has traded range-bound after a sharp rally in February and just topped the March high on Friday after the latest jobs report.
There are two arguments on why the dollar bull run is over. First, a Fed lift-off is already priced in. Second, the Federal Reserve is doing the dirty work for central bankers worldwide – the European Central Bank may be less inclined to ease in December now that the Fed will tighten. The odds of December rate hike is now at 68%.

Goldman’s Robin Brooks strongly refuted both arguments:

it is worth recalling how the greenback traded in late 2014, when the Fed diluted its forward guidance in September and December. On both occasions, the Dollar rallied 2-3 percent in the weeks that followed, in the absence of other catalysts. If markets are willing to reward a mere change in wording in this manner, we think there is little doubt that lift-off will be Dollar-positive. 

We put little stock in the idea that ECB policy is a function of the Fed. For one thing, there is little empirical evidence to suggest this.

While the Fed was moving in a hawkish direction last fall, moving away from forward guidance, the ECB was laying the groundwork for QE, beginning with the surprise deposit cut in September 2014. The Fed then shifted dovish in March this year, a shift it maintained through September, even as the Bund sell-off pointed to a more hawkish tack from the ECB. Finally, the ECB again shifted in a dovish direction in October, followed by a hawkish move from the Fed the same month. In short, both central banks look to be pursuing domestic objectives, which is of course what monetary policy should look like with freely floating exchange rates.

The U.S. dollar index has gained 9.9% this year mostly driven by the euro’s 11.3% fall. Goldman believes the euro will hit parity by this year-end. The euro was trading at 1.07 recently. Year-to-date, the Powershares DB US Dollar Index Bullish Fund (UUP) has gained 7.8%.

UPDATE: The U.S. dollar extended its gain in Asian markets on Monday morning. The Japanese yen fell 0.2% to 123.40, the Malaysian ringgit slumped 1% to 4.35, the Indonesian rupiah fell 0.66% to 13,654, and the Korean won dropped 0.94% to 1,152.74.