USD: More testing time for risk could ease dollar selling for now – MUFG

Analysts at MUFG Bank explained that recovery trades in equity prices suffer a setback after recent strong gains. They warn about a more cautious outlook for recovery trades that should limit USD selling. 

Key Quotes:

“There were building concerns that recent gains for risk assets and currencies had already had gone too far, too fast recently resulting in uncomfortably high valuations amidst the unprecedented hit to global economy from COVID-19. At the end of last week major US equity indices had almost fully reversed YTD losses following sharp declines of around 30% during February and March. Similar “v shaped” rebounds have also been evident in the FX market.”

“Our own QI RSI indicators have been signalling an increased risk of correction in recent weeks as the USD has become heavily oversold. The sell-off and subsequent recovery in risk assets and currencies has happened over a much shorter time frame than during the Global Financial Crisis.”

“The US economy fell into recession in December 2007 which lasted until May 2009 (18 months). It then took two years for the level of real GDP to rise beyond pre-GFC highs. The S&P 500 bottomed out around two months before the end of the GFC recession. The S&P 500 having already bottomed now in March is consistent with what timely, high frequency data is indicating – this recession is already over. But the sharp subsequent S&P 500 rebound certainly still looks inconsistent with consensus estimates of real GDP recovery by mid-2021/end-2021 and no doubt reflects the unprecedented provision of liquidity and optimism of a COVID vaccine.”

“In these circumstances, we believe that the upside for recovery trades is likely to prove more limited after strong gains in recent months. That may imply a period of consolidation for USD after the recent period of selling.”