FX Viewpoint | The last stretch of the USD’s cyclical decline | Article – HSBC VisionGo

The last stretch of the USD’s cyclical decline
Finance  ·    ·  3 mins read

  • The USD’s strength in the aftermath of the June FOMC decision has been significant and broad-based
  • Yet, we are still in the last stretch of the USD’s cyclical decline which has yet to reach a turning point
  • Higher shorter-dated US rates or a more significant global slowdown would be the key catalysts for the USD to strengthen more meaningfully, in our view

The USD’s strength has been significant and broad-based, since the 15-16 June Federal Open Market Committee (FOMC) meeting, with the new median dot showing two 25bp rate hikes by the end of 2023. The upward move by shorter-dated US Treasury yields has also been pronounced (see FX Spotlight: FOMC: USD goes dotty, 17 June 2021 for details).

The USD is still not behaving in a fully pro-cyclical manner to US data surprises, in our view

In our view, when the FX market is focused on the Federal Reserve’s (Fed) policy tightening, the USD should mostly exhibit pro-cyclical behaviour – strengthening when US data is good and weakening otherwise. Nevertheless, the USD is still not behaving like this. For example, the USD weakened after nonfarm payrolls beat expectations on 2 July and it strengthened on a day when the ISM services index disappointed expectations on 6 July (see chart below). Thus, we are in the last stretch of the USD’s cyclical decline that started in April 2020, and remain less convinced that its turning point has now been reached.

In our view, the broad USD should begin to bottom in the months ahead when the Fed starts tapering

To be clear, we are debating when the USD’s cyclical decline will end, rather than refuting the ending. Our long-standing view has focused on the actual start of the Fed’s tapering being supportive for the USD, although this should have greater meaning for the G10 than emerging markets (EM) FX, especially those major central banks that could be expanding their balance sheets in contrast to the Fed. 

Higher shorter-dated US rates or a more significant global slowdown could see the USD strengthening more meaningfully

One of the key risks to our short-term USD view is higher shorter-dated US Treasury yields (possibly due to a reduction in excess USD liquidity over time). We are also mindful of how global growth could be peaking on a sequential basis. If global growth momentum is truly peaking, even if the USD does not become pro-cyclical and stays anti-cyclical, it should nevertheless strengthen due to weaker risk appetite.

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