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The general direction of the Dollar is still pointed higher, according to new research.
Analysts at HSBC and Scandinavian lender SEB say the macroeconomic backdrop, central bank divergence and investor positioning all point to further advances by the greenback, particularly against the Euro.
"We believe the USD is gradually transitioning to a stronger path due to moderating global growth and the Fed edging closer towards eventual rate hikes," says HSBC's head of research, Paul Mackel.
This article is however published on a day that the Dollar is softer against the Euro, Pound and other major currencies in price action that suggests that clear directional trends will remain elusive.
"The trend may see less momentum and more common partial corrections higher," says Jussi Hiljanen, Chief Strategist, USD & EUR rates, at SEB.
Above: USD relative performance on Sept. 10
The Euro-to-Dollar exchange rate trades at 1.1830 at the time of writing, having seen a low of 1.1802 earlier this week but an open of 1.1881.
Dollar weakness seen on Friday coincides with a broadly positive investor sentiment backdrop ahead of the weekend, highlighted by rising stock markets and commodity prices.
The Dollar has benefited in 2021 when investor sentiment sours and position liquidation increases demand for the highly 'liquid' Dollar.
But the Dollar appreciated in value through the middle part of the year as another driver dominated investor discourse: the timing of the withdrawal of monetary support from the Federal Reserve.
Above: USD relative performance in 2021.
Investors have steadily built up expectations for the Fed to announce it would start winding down its quantitative easing programme by year-end, a target that still looks to be intact.
However, a speech by Federal Reserve Chair Jerome Powell at the Jackson Hole Symposium wrong-footed some in the market after he made clear that ending quantitative easing would not invite an interest rate rise soon after.
The pullback by the Dollar confirmed that interest rates are key to determining value and the focuss on the timing of tapering was just an attempt to get a better grasp of when that first hike might fall.
That higher U.S. rates could be further in the distance than previously anticipated has dragged on the USD since the speech.
"While we acknowledge Fed tapering may not lead to an immediate reaction and impact on the USD, we have little doubt this should set the course for wider policy divergence to play out for exchange rates," says Mackel.
The Euro has meanwhile found little succour from the European Central Bank's (ECB) September policy event of September 10.
The ECB said it would reduce its pandemic-era quantitative easing programme but warned that interest rates still remain some way off given inflation is unlikely to remain at or above 2.0% over the medium-term.
As such markets see the ECB as only raising rates in 2024.
This ECB-Fed divergence provides an enduring narrative for selling the Euro-Dollar.
SEB analysts reveal market positioning is consistent with expectations for a lower Euro-Dollar as recent buyers of upside in the exchange rate proved to be only interested in short-term contracts.
SEB note a build up of long Euro-Dollar trades ahead of the Jackson Hole speech, but "it seems they were not really long-term trades as even more long contracts have been exited (probably with a handsome profit) over the past two weeks."
"The lack of long-term commitment is interesting and some new short contracts, entered by speculators in general but also by leveraged funds in particular, suggest that there still is a belief that the trend lower in EUR/USD, that has prevailed since the peak on 25 May, will continue," says Hiljanen.
"We believe the dollar is gradually transitioning onto a stronger path," says Mackel, adding:
"The moderation in global growth and the Fed taking a gradual but divergent path towards eventual rate hikes. We acknowledge that the Fed’s tapering may not lead to an immediate reaction and impact on the USD.
"However, it should still set the course for bigger policy divergence to play out for exchange rates."
HSBC hold a point forecast on the Euro-to-Dollar exchange rate at 1.15 for the end of 2021, with 1.14 set for the end of the first quarter of 2022 and 1.13 for the end of the second quarter.
SEB's forecasts are 1.16, 1.15 and 1.15 for the same points.