US growth prospects may overtake investor risk appetite as the biggest factor driving the dollar, says HSBC

US growth prospects may overtake investor risk appetite as the biggest factor driving the dollar, says HSBC
Yousef Masoud/SOPA Images/LightRocket/Getty Images
  • The US dollar surged after Friday's jobs report that outstripped expectations.
  • The dollar's jump indicates a "US exceptionalism" theme is growing in influence, says HSBC.
  • HSBC said its work points to the potential of a floor under dollar selling being formed.

The US dollar immediately jumped after Friday's blowout US jobs report for February. HSBC says that the move suggests prospects for US economic growth -- or a theme of "US exceptionalism" -- rather than risk appetite, are beginning to gain influence over the direction of the greenback.

Risk appetite, or RORO, -- the investment bank's shorthand for "risk on-risk off" -- was the dominant influence over the dollar throughout 2020, leaving the safe-haven greenback down relative to other currencies. But the battle during 2021 has turned "finely balanced" following hints that the US exceptionalism theme that stokes dollar buying and strength appeared to be growing in sway.

"One of the key aspects of the dollar is normally 'the trend is your friend'. And, of course, if that trend is ebbing or that momentum is not what it used to be, it's causing a little bit of head-scratching and maybe an identity crisis for the dollar as to what matters," Daragh Maher, head of FX strategy at HSBC, told Insider, outlining the bank's new method of tracking what's driving the dollar.

"So what we tried to do is say, 'Let's be dispassionate and just see how the dollar is actually behaving. What is the FX market telling us?" he said. The new DRIVERS (Dollar Response In Various Economic Release Surprises) signal includes measuring the dollar's price action for 60 seconds against seven other currencies after an upside data surprise then comparing that with a level recorded a minute before a data release.

"What you're trying to catch is people's reflex rather than their more measured assessment," Maher said before the Labor Department on Friday released its monthly employment report.


Jobs climb, dollar leaps

The report showed the US economy added 379,000 jobs in February, trouncing expectations of 200,000 new jobs.

"The USD rallied initially after stronger US employment data, suggesting the theme of US exceptionalism is becoming more influential," HSBC said in a statement to Insider on Friday.

The rally underscored RORO's stalled momentum this year in guiding the dollar's direction. RORO is built on the theme of global reflation and is characterized by broad selling and weakness in the dollar after strong US economic data.

"What's going on is people are thinking, 'Hey, the US economy is doing much better, which means the global economy must be doing much better. So I'm going to start buying some riskier assets, which means I don't need to hold a safe haven like the dollar,'" Maher said.


RORO's influence last year in weakening the dollar had risen so much that its hold on the greenback tightened to levels not seen since 2013, HSBC said in a March 1 research note.

Separate from HSBC's analysis, the widely watched US Dollar Index ended 2020 by sliding 13% from mid-March 2020. That month, the index hit a three-year high on surging demand for dollars as the pandemic accelerated. So far in 2021, the index has gained more than 2%.

But the dollar's leap after Friday's jobs reports highlighted that traders were reacting to greater optimism about US growth partly as the US government moves toward unleashing a $1.9 trillion fiscal stimulus package to combat the economic pain inflicted by the pandemic.

Growth prospects, in turn, can fuel speculation about the Federal Reserve's next move on monetary policy. That perhaps "brings forward that taper conversation again. It brings forward people's expectations of when US rates might go up," said Maher. An interest rate hike by the Fed and tapering, or reducing, of the central bank's bond purchases, could boost the dollar's value and appeal.

To aid the economy through the coronavirus crisis, the Fed has kept its benchmark interest rate range at 0%-0.25% and has been buying $120 billion in bonds and mortgage-backed securities each month.


Maher said HSBC is not forecasting outright dollar strength this year. "What we're suggesting is that this shift in relative influence will put a floor under dollar selling."

The US exceptionalism theme took a brief hold over the dollar early in 2021 after some Fed officials indicated upside data surprises could lead to bond tapering this year. However, other Fed officials, including Fed Chairman Jerome Powell, pushed back against the taper talk.

"Over the next six months or so, we would expect to see some additional modest dollar weakens," Maher said. "But as the US economy continues to recover -- potentially boosted by additional fiscal stimulus - the narrative of Fed tapering and US exceptionalism is likely to become more influential towards the tail-end of this year."

The DRIVERS signal tracks the dollar's performance against the euro, the Japanese yen, the British pound, the Australian dollar, the Canadian dollar, the Swiss franc and the Mexican peso. HSBC tracks 30 data constituents of its US Economic Activity Surprise Index for DRIVERs.