Making Cents of the Dollar

A modest run on the U.S. dollar is under way. Over the past month, the greenback has lost nearly 5.5% against the New Zealand dollar, 4% against the Australian dollar, 3% against the Canadian dollar and more than 2% against sterling and the euro. While the U.S. currency is looking undervalued, valuations may get stretched even further before snapping back.

Several forces are at work driving this price action. They're not all negative for the dollar, but rather positive for the other currencies. The stream of robust economic news from New Zealand, Australia, the eurozone, the U.K., Sweden and Norway all point to the likelihood of additional near-term rate hikes.

As pricing in the futures market reflects, expectations for such rate hikes have been in place for some time. What have changed, however, are the growing suspicions that the hikes expected in the next few weeks won't signal the end of the tightening cycle, which is now anticipated to extend into the third quarter.

Interest Rate Differentials

This is taking place amid ideas, as reflected in the fed funds and eurodollar dollar futures, that the Federal Reserve may cut rates in the third quarter. The narrowing of interest rate differentials acts as a corrosive force on the dollar. The Euribor-Eurodollar futures spread has been fairly stable lately, but there's a different story slightly further out on the curve. Over the past five days, the two-year spreads narrowed by about 8 basis points to less than 50 basis points. This move is greater than the narrowing that had taken place in the previous three weeks.

Similarly, the 10-year spread between the U.S. and Germany narrowed 5 basis points over the past five sessions. At about 50 basis points, it stands at the narrowest level in nearly three years, matching in magnitude the decline of the previous three weeks.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.