This week, Fitch gave us our first real reality check since Standard & Poor’s August 2011 downgrade (“S&P cut the long-term U.S. credit rating by one notch to AA-plus on concerns about the government’s budget deficit and rising debt burden” - Reuters). That took a long time. After all, the US national debt has not fallen since then. The opposite has happened. However, with interest rates between 0.00 and 1.00% until the end of 2021, financing costs were not a big problem either. Of course, this has now changed (US2Y: 4.90% at time of writing). The USA in particular has reached a "milestone" in national debt by reaching the 1 trillion mark. This obviously left the rating agencies with no choice but to come out of the woodwork.
However, pointing the finger at the U.S. alone does not help us. With currency pairs, we have to compare one currency area with the other. Thus, the obvious solution of selling the dollar with a downgrade might be wrong. However, it is equally uncertain whether the dollar will be able to benefit from a potentially deteriorating risk sentiment this time as well. The dollar level today is much higher than in August 2011 (DXY monthly low: 73.45).
My base scenario for the coming weeks and months is that Fitch's downgrade is just the beginning of a volatile phase. This would also be consistent with my assumption that we will not see the low implied volatilities from the last observation point again for quite some time: “These impl Vols are almost at pre-crisis levels, where interest rates were at zero percent and central banks pumped massive amounts of money into the market. Let everyone decide for themselves whether today's monetary and economic situation is the same” (Market update #17). In this respect, the focus on FX options could solve the dilemma of the uncertain dollar development even at the current only slightly higher impl vol levels.
The dollar rally of the last two weeks is starting to look overbought. The next resistance is at 103 and after that the two highs at 103.55 (June 30) and 103.57 (July 6) come into play. Those who bought dollars on the last dip are not doing anything wrong by taking profit here. Especially against sterling and the yen, the dollar may have found its highs for the time being.*
Good luck,
Sebbo
(*reminder: my content is intended to be used and must be used for informational purposes only. It is very important to do your own analysis before making any investment based on your own personal circumstances.)