The turmoil in the markets since the new year shows little signs of abating in the short term. With added fears of Brexit and the continuing rout in the price of oil, Chinese turmoil risk is off signalled by the rapid appreciation of yen. Below is an interesting article looking dollar decoupling in this scenario.

The Return Of The USD-Decoupling Trade? – Credit Agricole

Risk sentiment worsened overnight as oil remained under pressure on the back of oversupply concerns and Fed Vice Chair Fisher reiterated his view that the bout of market uncertainty could be temporary and thus need not derail the economic recovery or hold the Fed’s tightening cycle in its tracks.

All this is seemingly supporting USD against most G10 currency with the greenback coming back from what some called the death of the policy divergence trade. To be sure, the USD-divergence trade took a heavy blow recently as investors pared back Fed tightening bets against the backdrop of global growth and inflation slowdown.

In the midst of all the risk aversion, however, the apparent improvement in the US data of late barely registered with the markets participants. Until now, that is. Indeed, recent discussions with clients have suggested that investors are noticing the improvement and warming up towards the USD yet again. In particular, recent data releases suggest that the tightening labour market conditions have helped boost wage growth, which, together with continuing gains in the house prices, helped fuel the core inflation in the US.

In addition, and potentially more importantly, accelerating wage growth and improving housing sector will make the US domestic demand-driven recovery more resilient to persistent global headwinds. This is because the US consumer spending (and by implication business capex) is propped up by three key pillars of household wealth: real wage income growth, house price and equity price gains. Immediately after Lehman, the US wage growth was negative and the housing sector was in the doldrums.

The Fed QE-fuelled rally in the US stock markets thus proved instrumenting in supporting the consumers’ purchasing power and spending. As the recovery in the US broadened and deepened, the slack in the US labour market and the overhang of unsold homes started disappearing and this helped boost both wage growth and house prices. Importantly, these developments are less correlated to the swings in global risk appetite than the US equity market. In turn, the US consumers could continue to spend even in the face of continuing stock market underperformance. By implication, the Fed is more likely to look through any bout of market volatility and focus instead on the continuing improvement in the labour markets and housing.

All of the above suggests that the USD-decoupling trade could recover some more in the near term especially if market risk sentiment improves on the back of a more constructive outcome of the G20 meeting. In addition, we expect the upcoming Fed speakers (Lacker and Kaplan today and Bullard, Lockhart and Williams tomorrow), to reiterate the view that the Fed is still on course to deliver further cautious tightening. So far, it seems that the USD is able to regain ground mainly against the risk correlated currencies as well as EUR and GBP. In the case of the EUR, positioning ahead of the ECB March 10 meeting seem to be weighing on EUR/USD as well. In the case of the latter, Brexit fears are likely keeping GBP/USD under pressure.

Copyright © 2016 Credit Agricole CIB, eFXnews™

This should now be at the forefront of you trading decisions. There are oppotunities to make money. The key thing is not to try to be catching falling knives.