US dollar loses its lustre, but for how long will it stay dim?

The Dollar Index, a weighted average of six main currencies against the US greenback, has lost the 93.00 level. The question remains for how long? The US Dollar Index sunk further, dipping below 93.00 to more than a two-year low as the euro rose above $1.1800, a two-year high.

Meanwhile, US stocks and gold continued to advance. We think the dollar can continue to trend lower on a sustained basis in the near-long term. That said, the USD is still about 10 percent overvalued, and is probably a drag on US global competitiveness. Net long euro positions, or bets on a stronger euro, are as big as they were just before EURUSD peaked in 2018. This echoes the dollar index position, referring to the net dollar short position or bets against the currency in the latest CFTC data.

On July 17, we called for a long EURUSD position with a target at $1.1600, which has been achieved. Here at Mansa-X, we will be looking to add onto that long Euro view with a revised target at $1.2000 in the medium-term. If and when we get to that level, then the rally will now be stretched.

We are still long EURUSD because we believe that the Euro is still undervalued versus the dollar despite its recent rally. However, the strong risk sentiment in the midst of a pandemic is still puzzling, indicating the disconnect between the markets and reality.

At Mansa-X we hold that the European Central Bank (ECB) could become more vocal in currency intervention measures if the euro exceeds the $1.2000 level, our medium-term target against the dollar.

The ECB cannot ignore the euro's recent gains given the disinflationary impact it could have on the Eurozone economy. Yet weakening the euro would be difficult as the Eurozone has a 2.8 percent current account surplus as a proportion of GDP whereas the US is still running a 2.1 percent deficit.

It is also hard to imagine the US government calling for a strong dollar ahead of November's presidential election.

Therefore, the ECB is unlikely to reverse the euro’s strength especially if there is a continuation of the region's smooth and steep reopening. Net long euro positions are at a two-year high on the approval of the EU coronavirus recovery fund despite the euro taking a breather after striking $1.1900.

The approval of the recovery fund in July was likely a key driver of another weekly rise in net long euro positions that bet on a stronger currency.

The EU recovery fund agreement supported the rise, although dynamics shown by other low-yielding currencies suggest speculators expect broad dollar declines.

Another supporting factor in the rise came after Germany's Bundesbank said it will keep participating in ECB's asset purchase programme following the resolution of a legal standoff with the country's constitutional court.

The timely resolution of the dispute has been important in boosting confidence in euro-zone assets and the euro in recent months.

Investors remain heavily overweight US equities, especially tech stocks, and are minded to rotate into Europe, and besides, the euro is still cheap.

The general trend for USD continues to be of decline, with the Covid-19 pandemic out of control in several States, dampening hopes of a quick economic recovery, forcing the Federal Reserve to maintain its accommodative stance and diminishing the appeal of dollar denominated assets.

At its recent monetary policy meeting, the US Federal Reserve Chairman stated that the impact of Fed asset buying is two-pronged. The bond buying is helping smooth market functioning, and providing stimulus, fostering a more accommodative monetary policy that supports macroeconomic outcomes.

The Federal Reserve also extended currency swap facilities through to March 31st, 2021. The extension of the Fed's dollar lending facilities for other central banks is not a sign of market distress.

Instead, it is about a backstop in unsettled times, to which the Swedish Central Bank extended its temporary swap agreement with the Federal Reserve Bank of New York as part of a wider deal to improve liquidity conditions.

The Riksbank entered the original deal in March 2020, allowing it to offer loans in USD against collateral to ensure continued good supply of one of the most important currencies for Swedish companies.

The agreement is part of a larger arrangement between the US Central Bank and a number of other central banks aimed at improving liquidity conditions on global financial markets. Simply put, more dollar supply in the markets.

Janot is senior dealer, Mansa X Fund — a product of Standard Investment Bank