- The US dollar has been on the recovery trail in recent weeks, climbing 3% from a more than three-year low reached in mid-February.
- Bank of America Merrill Lynch sees a shift occurring that could send the greenback higher, and it gives 8 reasons why traders should be buying.
After a prolonged period of weaker-than-expected performance, the US dollar is back grinding out gains.
The greenback has climbed 4% since hitting a more than three-year low roughly 10 weeks ago — and Bank of America Merrill Lynch sees a giant change afoot that could dictate its future.
It's referring to the recent increase in correlation between the euro-dollar currency cross and the 10-year Treasury swap rate differential. As you can see in the chart, the greenback and rates have historically traded in varying degrees of lockstep, with the measure only falling into negative territory recently.
It makes sense when you consider that the US is now firmly entrenched in a rising-interest-rate environment. And if the recent rebound (as indicated by the up-arrow) is any sign, the correlation would appear to be headed back into more normal territory.
"One of the more puzzling developments in financial markets over recent months has been the breakdown of the usually reliable correlation between the USD and interest rate differential," David Woo, BAML's head of global interest rates and currencies research, wrote in a client note. "There are signs that this anomaly may be coming to an end."
This is all a long-winded way of saying BAML thinks the dollar is going to keep climbing. And the firm has gone as far as to highlight eight reasons why traders should be selling the euro and buying the US dollar:
1) The continuation of "soft" April data in the eurozone — BAML says it "lends support to the 'euro is too strong' theory."
2) The recent recovery in US business investment — The firm says it's "paving the way for higher productivity and wage growth."
3) A likely NAFTA deal — BAML says it should "increase US leverage in trade negotiations with China."
4) Earnings season — US companies may use their first-quarter reports as an opportunity to repatriate their offshore cash, the firm says.
5) Continued deleveraging by China — This will "limit the ability of the PBOC to match further Fed hikes," according to BAML.
6) The flatness of the US yield curve, and the relative steepness of its eurozone counterpart — BAML says foreign investors will only consider currency unhedged investment in US bonds, and only hedged investment in eurozone fixed-income.
7) Fiscal risk premium — BAML notes it's already "very high" in the US dollar.
8) Divergence between momentum and positioning — It's "turning the tables on over-extended euro longs," the firm says.
