US Dollar: The upswing has begun

US Dollar: The upswing has begun

Forex 5 minutes to read
Charu Chanana

Chief Investment Strategist

Summary:  Treasury yields and dollar trajectory took a turn over the last week with economic data out of the US proving to be resilient. This has allowed the market to better absorb Powell’s message on further rate hikes and higher-for-longer, though still not fully so. The upswing in the dollar may have only begun if you consider the room for the markets to adjust to this new hawkish narrative, and gains could also extend further in H2 if non-US recession concerns deepen. With volatility staying low, dollar also provides a good carry and the path of least resistance appears to be going higher.


The path of the US dollar has been purely a function of the Federal Reserve policy expectations over the last two years. As expectations of a tighter policy ramped up, the USD gained strongly over the course of 2022, peaking eventually in September at a 20-year high. Since then, inflation in the US has been cooling, and expectations of a Fed pivot have been rampant. This drove the USD lower, with most gains coming in GBP and EUR, where the rate hike cycle is expected to be longer than the US.

The setup going into H2 however appears to be somewhat different. For one, investors have positioned for the end of the rate hike cycles somewhat prematurely, and second, there will be hovering risks of a slowdown or a recession as central banks continue to tighten. A few considerations could be important to assess the path of the US dollar from here.

More G10 (ex-Fed) rate hikes could spell desperation

The global central bank divergence has started to widen. While the Fed paused in June, Bank of England hiked rates by 50bps and the European Central Bank is expected to hike rates by 25bps. However, the market’s interpretation of rate hikes is now changing, with more rate hikes spelling cause of concern as inflation remains unanchored. This means more rate hikes wouldn’t necessarily translate into stronger currencies now. This was evident with the larger-than-expected rate hikes from Bank of England and Norges Bank last week, which failed to translate into stronger GBP or NOK by the end of the week.

Meanwhile, the market is still complacent about Fed rate hikes, with only another 35bps of rate hikes being priced in by the markets as against Powell’s message of two or more rate hikes, which suggests continued scope for a hawkish shift. With the Fed having paused in June, it is now being seen to be taking a measured approach without the sense of urgency that some of the other central bankers have that have been behind the curve (ECB, BOE and RBA).

Figure 1: Comparison between peak rates priced in and 2023 inflation forecasts. Source: Bloomberg, Saxo

Dollar serves as an insurance in recessions

As the rate hikes from the global central banks filter through to the economy, there is likely to be rising risks of an economic slowdown. Even as the markets are currently looking more positive h as the banking crisis and debt ceiling risks having been averted, but focus on economic data will likely be back in H2. That said, any recession in the US is likely to be shallow as household and non-financial corporations’ balance sheets remain relatively healthy.

Recession risks are more pronounced for UK or the Eurozone, which need to hike more aggressively, likely bringing a recession to their economies to get a handle on their inflation which still remains above US inflation. Earlier in the year, it appeared that that growth numbers in Europe and China would accelerate and widen the gap against the US. However, that has not played out, and recession risks remain more prominent outside the US. This could spur demand for the safe-haven dollar.

Supplementing returns with carry

With markets traditionally quieting down significantly over the incoming summer months, it can be expected that implied and realised volatility could continue to decline. Meanwhile, yields are expected to remain high, and that could bring back interest in FX carry trades where investors borrow in low–interest rate currencies to invest in high–interest rate currencies and pocket the spread. US interest rates are now high compared to the extremely low (or negative) rates in countries like Japan or Switzerland. This could bring USD carry trade in focus with the US economy still looking healthier than most other countries, as against EM carry trades that are usually in focus in case of a higher chance of a US-centric recession.

Return of the geopolitical tensions

Last weekend’s reports of Russian mutiny have brought geopolitical concerns back on the table. While an immediate threat to Putin has been averted with the situation being de-escalated, there remain risks of renewed tensions as Putin fears losing his grip. The incident has exposed the underlying instability in the geopolitical world order, and will likely boost safe-haven appeal of the US dollar. More so, geopolitical tensions have also been aroused again this week in the semiconductor industry with US adding to its export curbs of chips in several ways including new chip designs and technologies.

Market implications

The dollar upswing has begun, and has room to run. FX is a relative game, and buying dollars will mean selling another currency. AUD may remain the most exposed, given that the Reserve Bank of Australia appears to be favouring a pause after its two surprise rate hikes recently. China stimulus measures have remains slower and more measured, disappointing those looking for a significant growth push. CNH also remains vulnerable to slowing China growth.

The key risk to consider could be a sudden move by Japanese or China authorities to support their currencies that have been witnessing a rapid pace of deterioration recently. A sudden pullback in liquidity could also disrupt the near-term USD strengthening trend.

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)


Business Hills Park – Building 4,
4th Floor, office 401, Dubai Hills Estate, P.O. Box 33641, Dubai, UAE

Contact Saxo

Select region

UAE
UAE

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.