Goldman with the note
USD: Who you gonna run to?
There have been different phases to the Dollar’s resilience this year. January brought a reversal of the December FOMC “pivot party” following stronger inflation and activity data.
In February, the Dollar traded in the middle of the pack as markets priced broad cyclical optimism.
Through much of the year, a lack of policy divergence and broadly better growth data have left the high-carry, highly-valued safe-haven without a clear trend.
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More recently, the prospect of an even slower Fed adjustment gave a fresh boost to the Dollar against policy sensitive crosses and led us to change our forecasts—we now expect the Dollar to be “stronger for longer.”
We also think there are signs that the FX regime is shifting again towards a different type of Dollar strength.
As our rates strategists have noted, markets have begun to price more of a policy shift rather than just better activity data.
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This can lead to more disruptive Dollar moves against cyclical, rates-sensitive currencies, as we saw in the middle of last year (Exhibit 1).
Most importantly, a yield up and equities down market tends to be the environment that facilitates the broadest Dollar strength.
Market moves this week also show how sensitive risk sentiment has become to this prospect in both directions, with an outsized Dollar decline following a downside surprise in the flash PMIs—a relatively minor data point—and further market “relief” from a low-quality miss in the Q1 GDP report (we think the details of the release were actually positive for USD on net).
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The sensitivity is understandable, and markets will scrutinize next week’s employment report for signs of cooling, but we think the balance of risks points to a stronger Dollar.
The cyclical upgrade has started to morph into more of a policy repricing, and next week’s FOMC meeting will at the very least reiterate that the Committee is not feeling any more confident about the inflation outlook, as Chair Powell has already established, which could reinforce this concern.
But even if the FOMC makes a smaller reassessment than the shift in market pricing suggests, this should not have a lasting impact in FX, where the magnitude of the cycle matters more than the timing. Investors should consider hedging against these risks with Dollar calls against rates-sensitive crosses in both DM (like AUD and SEK) and EM (see below) that were previously protected by the procyclical rotation but that would be more exposed in a “policy shock” environment.
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The US is a long-rate economy, whereas Australia is a short-rate economy. In forex terms, this pits the RBA not against the Fed but the long-bond.
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If both turn to higher rates, the long-bond will win, not least because Aussie long yields will begin to fall towards a harder landing.
But I do not expect the RBA to hike anyway.
