The month of April was not a good one for dollar bulls. The greenback has posted its first monthly decline of 2021, erasing over 2 per cent of its value against six major currencies.

According to the latest data from the Commodity Futures Trading Commission, the net short positions on the dollar reached $10.27 billion against its major peers. That is more than $2 billion net shorts added compared to a week earlier and the highest in six weeks.

The dollar’s decline followed three back-to-back monthly gains as data began to show the US economy recovering at an amazingly fast pace, leading to higher inflation expectations and bond yields suggesting sooner than anticipated tightening in monetary policy.

However, the Federal Reserve did not agree with the market’s view and remained committed to keeping monetary policy extremely loose last week at its policy meeting, setting a high bar for any start date to reduce the pace of its asset purchases. The Fed requires substantial further progress in reaching its employment goals before starting the tapering process. Given the US labour market remains 8.4 million jobs short of its pre-pandemic employment levels, it seems there’s still a long way to go.

Data on Friday revealed a surge in US personal spending, personal income, personal consumption expenditure and consumer sentiment. This was a reminder of how far the US economy is outperforming other developed nations, especially after the Eurozone’s first quarter GDP report showed the continent had fallen into a double dip recession.

Given the market is a forward-looking mechanism, it tends to incorporate all currently known information and anticipated events. The narrative now is that the rest of the global economy continues to struggle with the Covid-19 pandemic but will sooner rather than later catch up with the US. However, latest Covid developments in India, Brazil and Turkey should be a reminder not to take anything for granted. The divergence of the global economy may or may not narrow depending on how these issues play out.

This week’s economic data will likely show the ongoing recovery in the US in the hard hit services sector, after the activity index jumped to a record high in March. Manufacturing activity is also expected to continue booming. On Friday, we will learn how many jobs were added to the US economy in April after 916,000 Americans found jobs in March. If we see an uptick in US 10-year yields towards 1.7%, this should become supportive of the US dollar, otherwise the global reflation trade will continue to pressure the greenback.

Despite Fed Chair Jerome Powell continuing to insist that inflationary pressures are transitory in nature, if commodity prices continue to surge and push breakeven rates higher, the Fed will need to change its language. We are already seeing member’s views diverging from Powell, with Dallas Fed President Robert Kaplan saying on Friday that any signs of excessive risk-taking would suggest it is time to consider fewer bond purchases. An increasing amount of similar voices could completely change the narrative in the market from a global economy narrowing the gap with the US to a one of the US tightening policy first.

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