Storm clouds gather for the global economy, but the sun continues to shine for the USD

This week, bond yields hit levels not seen since the 2007/8 financial crash, and oil prices dropped by over 5%. Earlier in the week, stocks crashed, and the VIX, the famous “fear index”, climbed to its highest level since March, showing that investors were taking the sudden increase in bond yields seriously.

Writing in the Financial Times on Thursday, October 5^th, Mohamed El-Erian, former CEO of PIMCO and chief economic adviser at Allianz, said:

“For well over a year now, I have argued that the US is able to avoid the 2023 recession that many were repeatedly calling. I am now less confident about what’s in store for 2024 given how the recent surge in rates compounds the erosion in financial, human, and institutional resilience.”

Markets have been nervous all year, with analysts poring over data for signs of a slowdown as interest rates climbed ever higher, and it looks like we might finally be seeing the consequences of the long battle with inflation.

But what looks like bad news for the global economy will be good news for the USD – at least in the short term.

The USD has been on an extraordinary run recently. So far this week, the DXY, an index which measures the USD against a basket of other currencies, has risen 0.8%. This puts the index on track for its longest winning streak since 2014. Traders have become increasingly bullish on the DXY, with long positions on the dollar now at their highest level in 11 months.

Given the fundamentals driving the USD’s gains against other currencies, it’s no surprise that the mood is so bullish amongst USD traders. The Fed’s “higher-for-longer” stance on interest rates would keep the USD supported anyway, especially as the ECB and the Bank of England have thrown in the proverbial towel as their respective economies have failed to show the same resilience seen in the US.

In addition, with bond yields spiking, we are now in particularly dangerous territory for a stretched private sector. Borrowing costs will get more expensive, just as the US economy shows signs of slowing and higher energy prices begin to bite. While most eyes are focused on the US, the consequences for the global economy will be severe, especially as ongoing Chinese economic weakness means there is no one to pick up the slack.

The maelstrom of bad economic news has boosted the USD as a safe-haven, and will continue to do so until the end of the year. But with a US recession now looking likely and the EUR/USD heading deep into oversold territory, the outlook for 2024 is much less clear – with a big correction possibly on the cards for the early or middle part of next year.

On the Technical Front

The US Dollar index edged lower for the second day in a row after reaching a new 2023 high but found resistance at 107.00 (50% Fibonacci Retracement level) on Tuesday. However, although the index appears overbought, with the RSI bouncing up around the 70% level, it is still poised for further upside moves, with signals that the Fed may hike interest rates again before the end of the year.

Further short-term downside moves could find immediate trendline support at 105.72, and lower than this, at the 38.2 Fibonacci retracement level of 105.21.

Dollar Index Daily Chart

On the EUR/USD front, the Euro recovered from its weakest level in almost a year against the dollar, at 1.0449, having breached the psychological support at 105.00 on the 27^th of September, 2023. Despite the recent upside moves, the EUR remains under severe pressure, with the long-term trend favouring the dollar, and the RSI having moved out of oversold territory.

EUR/USD Daily Chart