The DXY index ended last week slightly higher, recording its first weekly gain since mid-June.

After jumping at the beginning of the Covid-19 pandemic due to strong demand for liquidity, the US dollar is steadily eroding. In July, its DXY index recorded its worst monthly performance in a decade, with a fall of 4.1% bringing to 9% its decline since the peak reached in March.

Nevertheless, the DXY dollar index ended last week slightly higher, recording its first weekly gain since mid-June. The consolidation of the dollar is expected to continue.

UBS Research has identified three factors that could lead to a pause in the depreciation trend of the greenback that could, in the short term, regain some of the lost ground.

Worrying developments in Europe
In recent weeks, the depreciation of the dollar is partly the result of the sharp rise in the number of coronavirus cases in some areas of the United States. Now, the Covid-19 epidemic seems to be slowing down. Indeed, during the weekend of August 8 and 9, new cases increased by only 1% on average, compared to 1.6% on average during the previous five weekends.

Net short positions on the dollar against the euro held by
speculative accounts reached their highest level since 2018.
On the other side of the Atlantic, the number of new cases is growing faster. On August 7, in Germany, the transmission rate climbed to 1.16, its highest level in ten days. While in Italy, the number of new cases is at the highest in two months.

THREAT OF A BUDGET CLIFF
The spectre of a "fiscal cliff" in the United States with the expiration of supplementary unemployment benefits has also weighed on the dollar. Negotiations between Democrats and Republicans are at an impasse, so much so that President Donald Trump last weekend signed four executive orders approving a series of fiscal stimulus measures. Among them, aid of $ 400 per week in the same vein as the CARES (Coronavirus Aid, Relief, and Economic Security) device that has expired.

Congressmen have not yet reached an agreement. However, as the presidential election approaches, democrats and Republicans alike have a vested interest in it. Thus, it is likely that a new stimulus package of at least $1 trillion will be adopted. This should give the greenback some respite.

SHORT POSITIONS ON THE RISE
According to data from the CFTC (Commodity Futures Trading Commission), net short positions on the dollar against the euro held by speculative accounts reached their highest level since 2018. Hence the potential for profit-taking if the news ever becomes more favorable to the dollar.

Regarding the EURUSD exchange rate, the dollar
will certainly depreciate to 1.22 by September 2021.
Nevertheless, in the longer term, the dollar's downward trend remains intact even though its depreciation will certainly be slower. Explanation in three points as well.

Extremely loose fiscal and monetary policies in the United States, which have led to an erosion of the interest rate differential in favour of the dollar, are expected to continue.
Uncertainty about the outcome of the U.S. election will likely continue to weigh on the dollar. Even after the presidential election, fiscal policy uncertainty and the size of U.S. debt could continue to undermine the greenback.
Prior to the Covid-19 crisis, many long-term investors had exceptionally high exposure to the dollar in order to take advantage of the considerable interest rate differential between the greenback and other funding currencies such as the Swiss franc and the yen. They will probably remedy this overexposure. Indeed, cftc data show an increase in net long positions in the euro held by asset managers, which rose from 223,000 to 337,000 contracts between the end of May and the end of July.
Therefore, from a tactical point of view, this is not the time to speculate on a further depreciation of the dollar. But, given the longer-term trend, investors would do well to look at their strategic positioning and change it if necessary.

As for the EURUSD exchange rate, the dollar will certainly depreciate to 1.22 (in the middle of the 1.20-1.25 range) by September 2021. One would be tempted to increase exposure to the euro when the pair falls back to 1.15-1.16. For the USDCHF pair, UBS Research has set its price target at 0.90 over the same horizon. The Swiss National Bank has recently reduced its intervention in the foreign exchange market, but it should continue to intervene to limit the appreciation of the Swiss franc.