Dollar's comeback beginning to look 'appealing' as U.S. stocks enter rally mode

© Reuters

By Yasin Ebrahim

Investing.com -- The dollar has faced hammer blow after hammer blow in its attempts to hold ground against rivals, but the greenback is finally starting to look 'appealing' as U.S. equities pick up steam against their European rivals.

The U.S. dollar index, which measures the greenback against a trade-weighted basket of six major currencies, rose by 0.1% to 101.72. 

“[W]e think a long USD position is beginning to look appealing again, perhaps even from a tactical perspective,” Danske Bank said, according to Forexlive.

The bank pointed to EUR/USD losing steam and Eurozone equities beginning to underperform U.S. peers as a source of hope for the dollar.

The MSCI's broad index of European shares, ex-UK, is up 8.8% so far in January, versus 6% in the U.S.

But much of the outperformance has been based on a “Goldilocks scenario," Amundi says, pointing to expectations that the Eurozone will still churn out economic growth, underpinning earnings while central banks will pause from hikes.

But European stocks aren’t pricing the need for the ECB to continue with rate hikes as inflation will remain high.

"We could expect a consolidation of 15% to 20% from current levels," on European equity indices, Amundi Chief Invesment Officer Vincent Mortier told Reuters, adding that while the rally could still persist for months or weeks, “the drop, the normalisation, will happen."

There are many, however, who would suggest the underperformance is an aberration and point to rapid investment inflows into Europe.

Investors poured $3.4 billion into European stock funds in the week through Wednesday, Bank of America said in a note, adding that the inflows into European stocks were the largest since February 2022.

Still the recent rally in U.S. stocks versus their European peers gives credence to expectations that it may not be all one-way traffic higher for European stocks.

Over the past week, there have been signs European equities have underperformed their U.S. peers, rising just 0.6% versus the S&P 500’s 2.4%.

Others, however, believe there isn’t any catalyst for a reversal in the dollar’s decline unless the Fed delivers an unlikely hawkish surprise next week.

“Barring a 50bp hike or a conditional commitment to stop tightening, the bar is high to flip the switch on the status quo. USD is stretched and oversold, but the catalyst for a reversal is absent,” TD Securities said.