Focus on USD

FX Focus

The attractiveness of the USD has diminished in recent months, partly attributed to the erosion of its relative interest rate advantage. Investors have been adjusting their positions in anticipation of forthcoming aggressive interest rate cuts by the Federal Reserve (Fed). Nevertheless, I remain sceptical that the Fed's shift in monetary policy after reaching the peak of its tightening cycle in May would turn out to be as accommodative as expected. Consequently, I believe the USD could stabilize as the Federal Open Market Committee (FOMC) persists in pushing back against market expectations of rate cuts.

In this part (https://acy.com.au/en/market-news/market-analysis/looking-beyond-the-usd-smile-l-s-132312/) of the analytical/analysis piece, I analyse the influence of various factors that have contributed to the diminished attractiveness of the USD in recent weeks. These factors include: (1) the process of de-dollarization, which entails a reduction in the reliance on the USD as a global reserve currency; (2) concerns surrounding the US debt ceiling, which could impact the creditworthiness of the US government; and (3) the potential onset of a US economic downturn, which could negatively impact the performance of the USD.

Beginning with the first factor (1), I have determined that the consequences of de-dollarization are likely to manifest gradually, spanning an extended timeframe. Additionally, I hold the view that the USD could experience positive effects from capital inflows into the United States because of the phenomenon known as "friendshoring" (Explanation of friendshoring here: https://www.ft.com/content/b2f66486-80e5-425e-86e7-fe432da8aeec) in the upcoming quarters. These inflows may precede any significant and enduring shift in foreign exchange reserves of emerging market central banks away from the USD.

Regarding factors (2) and (3), my assessments indicate that historical trends demonstrate a negative impact on the USD when there is a deterioration in the quality of US economic data or concerns arise about a potential sovereign default. However, these losses have predominantly affected the USD's performance against safe-haven assets such as the CHF, JPY, and gold. Simultaneously, these drivers have also generated negative effects on overall risk sentiment, thereby enabling the USD to outperform currencies that are closely correlated with risk appetite.

Overall, the current pricing of the USD already incorporates several negative factors, and I anticipate that a potential decline in risk sentiment over the coming months could contribute to a partial recovery for the USD. Moreover, I maintain the belief that the long-term outlook for the USD could potentially be more positive.

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