It has been a rough week for the U.S. dollar. The greenback traded lower against all of the major currencies, falling to multi-month and, in some cases, multi-year lows in the process. USD/JPY, which has been consolidating in a tight range for more than a week, finally broke down on Friday, dropping below 106 to its weakest level in four months. The U.S. dollar’s weakness was the most pronounced against the euro and Australian dollar – EUR/USD rose to its highest level since September 2018, while AUD/USD hit a one-year high. Chances are, investors will continue to sell U.S. dollars in the coming week for the following reasons:
#1 – Extra Jobless Benefits Disappear
Come Monday, more than 20 million Americans will lose the $600-a-week extra unemployment benefits that kept them afloat for the past few months. The official deadline is July 31, but based on the way states calculate and pay these benefits, the last payment for most people would be July 25 or July 26. Not only will these households see an immediate drop in income, but many businesses, such as grocery stores and retailers, will feel the effects as well. Unless these benefits are extended quickly, we’ll see more foreclosures, bankruptcies and, in turn, more retail job losses. The fear of the recovery unraveling could send the U.S. dollar to fresh lows. Congress is struggling to come up with another relief package, but the supplement it ends up providing won’t be as generous. At most we expect it to pay 70% of prior income but the average extra payment to unemployed Americans could fall to as low as $200 a week. With the funeral and remembrance ceremonies for former U.S. Representative John Lewis scheduled for the coming week, the real negotiations won’t begin until the first week of August.
#2 – Double-Digit Contraction Coming for Second Quarter U.S. GDP
Second quarter U.S. GDP numbers are also scheduled for release, and as so well put by Tim Smart, executive editor of US News (yes, I know), it might turn into a third-quarter hangover for the markets. Lockdown measures were first implemented at the end of the first quarter and the shutdown in activity caused a 5% contraction in GDP. Nearly all U.S. states were in full lockdown for the better part of Q2 and economists expect a 35% contraction in growth. Unfortunately, the data could be much worse as the Atlanta Fed predicts a 52.8% decline. Anything in excess of 40% will be a shock that could send equities and currencies plunging lower. USD/JPY in particular will fall quickly and aggressively. Even if the data is better, the U.S. dollar could decline versus high-beta currencies such as the euro, as the market compares the contraction in the U.S. with the expected 12% drop in GDP projected for the Eurozone in the same quarter.
#3 – Federal Reserve Meeting
The two greatest threats to the U.S. economy are two things the Federal Reserve has no control over – the rapid spread of coronavirus in the U.S. and the government’s fiscal response. A few weeks ago, Fed Chairman Jerome Powell warned lawmakers not to become complacent as the U.S. economy remains extraordinarily uncertain. Since then, the outlook worsened, extra unemployment benefits expired and the packages that Congress is discussing could fail to impress. For all of the reasons, we expect nothing but ongoing dovishness from the Fed along with a pledge to keep monetary policy accommodative for the foreseeable future. Last month, they said rates will remain at zero through 2022. How the U.S. dollar trades will depend on Powell’s tone. Back in June, he said a second-half recovery is likely, but with virus cases rising rapidly, his outlook may have dimmed. The big question is negative rates – any mention of that being an option will be bruising for the dollar. Regardless, we expect the greenback to extend its slide before and after FOMC.