Could the USD change direction on further risk aversion?

Yesterday saw a justified meltdown in risky assets as markets absorbed the blow of Trump’s far larger than expected tariff rates the US will impose on global trading partners, with the mercantilist policies of China and southeast Asia most clearly in the cross-hairs of the Trump administration. So far, the euro, yen and especially the Swiss franc have served as safe havens, while the US dollar weakened broadly. The narrative driving the US dollar lower is one of reduced portfolio allocations to the US as the policy will bring most disruption to the US economy in the near term. As well, the market is aggressively positioning for the Fed to deliver more cuts this year – at current count a full 100 basis points of easing by year end. The inflation outlook has certainly been helped along by the collapse in crude oil prices yesterday as well, with OPEC+ dramatic policy move to raise production yesterday more than anticipated, perhaps a bid to put the US shale market out of commission.

But I wonder if we may be at risk of a sudden reversal in the very short term to some of the current market developments if the ugly moves in global markets turn into a more pronounced deleveraging event. The AUDUSD move overnight is an interesting one in that light – after all, who wants to load up on AUD when the US tariff schedule could crater demand for Chinese exports and any stimulus China is set to announce is aimed more at consumption rather than the old fashioned kind of massive fixed asset investment that used to mean huge demand for all that Australia exports? In short, if markets turn truly white knuckle, the market may just be looking for liquidity, which could mean demand for US dollars and a USD spike, at least against the less liquid and traditionally pro-cyclical currencies, from sterling and the Swedish krone, to Asian currencies, etc.

Chart: GBPUSD
GBPUSD rushed higher as the US dollar weakened on the back of Trump’s Liberation Day tariffs. It feels extremely unusual to see sterling ripping higher against the US dollar in a time of severe market distress and I wonder if this move above 1.3000 can hold if we are set to suffer further volatility across global markets. Certainly, the Bank of England is also at risk of some repricing lower here as well. Longer term, the US dollar’s trajectory is set to go lower, but I wouldn’t count out the ability of the greenback to make life difficult for the bears in the near term.