Euro – dollar has been under intense pressure in recent weeks after it was unveiled that the Federal Reserve was planning to raise interest rates during its December meeting, while the European Central Bank was planning to add to its stimulus measures in the same month. Specifically, the euro came tumbling down from its 1.1494 peak (not far from its high for the year) in mid-October to below the 1.07 level on November 10th.
During this period, Fed Governors have been preparing the market for the possibility of a rate hike and there was some impressive economic data out of the United States in the form of very strong employment numbers. Across the ocean, Mario Draghi and his fellow ECB Council members have been dropping hints in the other direction; mainly that the Quantitative Easing program would be enlarged or extended and that the deposit rate – already at -0.20% – would be cut even deeper into negative territory.
Given the violent moves from almost 1.15 to 1.07, it is worth asking how much has the market already discounted. Will it be a case of ‘buying the rumor and selling the fact’ when the two most powerful central banks in the world meet in December and decide what is expected of them? Indeed it is interesting that the euro actually posted a small gain overall against the dollar this week, even though there was nothing to suggest a change in the Fed’s tightening intentions or the ECB’s plans for extra stimulus – quite the opposite in fact if one judges by policymakers’ speeches.
Therefore, given the already very bullish sentiment in favor of the dollar, it is possible that excessive long dollar positioning could prevent the US dollar from making further quick gains in coming days and weeks. Those in a hurry to see 1.05 and parity might need to wait a while before they takes place. The medium-term trend for the dollar is still positive and if the Fed executes one or two more hikes during 2016 while the ECB stays with its stimulus plans, euro – dollar will head down again just maybe not right now.
Another asset class that has been hurt by dollar strength has been commodities. This week in particular, US crude oil dipped below $42 a barrel and gold tested the $1080 per ounce level. Weakness in gold prices can of course be significantly attributed to the stronger dollar, but oil prices have been weak mainly as a result of a demand – supply imbalance. In fact, inventories of crude oil have been rising as supply from the world’s top exporters continues to increase while demand is not growing as quickly so as to absorb the extra supply. Inventory growth has been a factor that is applying persistent pressure on oil and the ultimate bottom in oil is a subject of intense speculation.
In the long-run however, the drop in prices is forcing oil companies to shelve expansion plans and postpone investment projects that will provide future supply. In addition, some of the innovative methods that allowed the extraction of shale oil or oil from tar sands or from ocean floor drilling, could be put on hold for now as they may not be economical. This limit in supply will surely be a factor that will help the oil price to recover in the long-run. For now, as long as supply exceeds demand and the outlook is bearish, it is dangerous to fish for a bottom.
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