USD

Federal Reserve officials are clearly signalling increasing discomfort with the level of restrictiveness implied in real policy rates. If all else were equal, the dollar would come under sustained selling pressure in the months ahead. But exchange rates have already moved dramatically: Hedge funds and other large speculators are holding a net short position against the dollar for the first time since September, and the greenback has fallen more than 4 percent from its October highs as markets have turned optimistic on returns outside the United States. And all else isn’t equal: Although inflation is headed in the same direction...

For all their drama, presidential elections typically have very little impact on the economy’s near-term direction, and often leave exchange rates effectively unmoved. But in 2024, the stakes for currency markets will be higher. In early campaigning, Donald Trump – the presumptive Republican nominee – has threatened to apply a “universal baseline” ten-percent tariff on all imports – a step that could inflict damage on the dollar’s major counterparts in a repeat of the dynamics seen after the vote in 2016. We think volatility term structures in foreign exchange markets will develop kinks around November’s polling date as the year...

We are directionally aligned with consensus – like most observers, we believe the greenback will ultimately weaken in 2024 – but we think its descent will be more turbulent than others expect. A number of factors could upset prevailing views: If markets begin questioning the soft landing thesis in earnest, “dollar smile” dynamics could see capital flows re-routed back into US financial markets, triggering a sustained rally in the greenback. Signs of stubbornly sticky inflation might drive a reappraisal across developed-market yield curves, weighing on high-beta currencies. A stimulus-led acceleration in China could lift commodity benchmarks and impact price expectations...