A new round of intense currency wars has come to an end! With the rebound of the Fed's interest rate cut expectations, the US dollar index fluctuated downward, with a drop of over 1% in the past two weeks, currently hovering around the 105 level.
Some market participants are worried that the strong US dollar over the past month may be difficult to sustain, similar to the situation at the end of last year when interest rate cut expectations surged, long positions on the US dollar peaked, and significant improvements in economic growth outside the US put downward pressure on the dollar.
However, Barclays believes that this time is quite different. Analyst Themistoklis Fiotakis stated in a report released in early May that compared to October last year, the current fundamentals have stronger support for US policy interest rates, but the market is pricing this risk lower, indicating that the US dollar is likely to remain strong in the near future.
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In contrast to October last year, inflation is now accelerating. Based on data from three consecutive months, the annualized growth rate of the US core CPI is currently 4.5%, much higher than the 3.2% in October last year.
The pricing of US 2-year Treasury yields is much lower than in October. The Fed's dovish stance has decreased, and the market has indeed repriced this.
However, if the inflation rate does not significantly slow down from its current level, even if Fed officials' remarks may lean towards maintaining low rates, the market may not buy it, leading to the 2-year Treasury yield returning to the high levels of October last year, or even rising further to account for future rate hikes.
Furthermore, in stark contrast to October last year, the inflation dynamics in the US are decoupling from the rest of the world, with inflation in other G10 countries trending downwards while accelerating in the US.
The Fed, once seen as the most hawkish central bank in the market in October last year, has now seen a change in market perception. The Fed is no longer seen as the most hawkish central bank, but has become one of the relatively &#34;dovish&#34; central banks, similar to the stance of the European Central Bank. Despite the similarity in policy stances between the two central banks, the different economic conditions they may face mean that there are still significant divergences in their monetary policies, which are widening.
However, Barclays points out that China's economic growth momentum is now improving, which in turn puts pressure on the US dollar. Additionally, economic data outside the US has unexpectedly improved (including in Europe), which will also reduce the attractiveness of the US dollar
In addition, the market's pursuit of the US dollar is also weakening.
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Although the euro has dropped 4 to 5 significant price points from recent highs against the US dollar, it is still far from the low point in October 2023. In the end, our expectation of a large-scale purchase of the US dollar by the end of the month has not materialized much.
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Similar to Barclays, HSBC is more cautiously optimistic about the US dollar.
HSBC believes that the level of US bond yields, central banks outside the Federal Reserve turning &#34;dovish,&#34; and the frenzy for safe-haven assets may provide some support for the US dollar's rise, expecting the US dollar to remain strong and potentially rise to 107 in the short term

Barclays believes that compared to October last year, the current fundamentals provide stronger support for US policy interest rates, but the market is pricing this risk lower. This suggests that the US dollar is expected to continue its strength in the near future

How long can the strong US dollar last?