Easing pressure on the US dollar from stability in commodity markets should allow the Federal Reserve to step up the pace of its monetary tightening, says Societe Generale.
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The Paris-based investment bank says although greenback appreciation has been partly driven by anticipation of Fed interest rates rises, the role of commodity output and demand has been just as big.
The two forces working together have, at various times, made the greenback too strong for the Fed's liking, forcing delays in the follow-up interest rate rise to last December's lift-off after nearly 10 years.
This, however, is unwinding as conventional supply and demand dynamics are reinstated in energy and metals markets, letting the Fed get on with lifting interest rates.
Commodities are linked to the US currency because most of them are priced in dollars. When the dollar is high, demand for oil and other commodities flags, putting downward pressure on market prices.
Supply, however, fails to adjust as producers reap the benefits of being paid in a highly valued currency, as local inputs costs decline.
This, in turn, puts additional downward pressure on commodity prices.
Negative feedback loop
As market pricing of raw materials softens, the relative value of producer currencies in the both developing and advanced economies falls, strengthening the greenback as institutional investors, governments and companies pile into safe-haven assets.
This helps explain sharp downward movement in the Aussie dollar in time of oil or iron ore price weakness.
However, this "negative feedback loop" may start to unwind now that supply and demand of oil and other raw materials are nearing equilibrium, according to Societe Generale.
"In the past two years, this normal causality from dollar to oil was reinforced by the oversupply in the oil markets which exacerbated the downward pressure on prices and drove further dollar strength," wrote the bank's chief US economist Aneta Markowska.
"With the oil markets projected to be roughly balanced in the second half of this year, and with inventories expected to decline next year, the negative feedback loop between dollar and oil should finally be broken.
"As a result, the dollar's tendency to appreciate should diminish notably," she said.
Rate rise imminent
This just leaves intensifying expectations that the Fed will raise rates either next month or in July as the main driver of current greenback strength.
On Monday, the greenback began to ease slightly against most major currencies after a sharp increase over the weekend.
The trigger was comments from Fed chair Janet Yellen suggesting the long-awaited second rate rise in the current cycle was imminent.
The Australian dollar was fetching US71.55¢ in late afternoon trade, compared with around US72.30¢ on Friday.