USD: The correction may not last long
The dollar suffered a sizeable correction across the board yesterday, which was primarily fuelled by two factors: a significant rebound in global risk assets, and a growing narrative of other central banks closing the gap with the Federal Reserve. From a more technical perspective, it is likely that some position-squaring moves in the oversold dollar exacerbated the magnitude of the correction.
Now, the question is whether yesterday’s moves have marked the first stage of a dollar depreciating trend from its cyclical peak. While we wouldn’t completely rule this out, the risks to a bearish dollar scenario remain quite elevated.
First, the perceived shrinking of the Fed's advantage over other central banks appears – in our view – based in many instances on excessively hawkish pricing for tightening by those central banks. The most notable examples are the European Central Bank and Bank of England. While a 50bp move at their next meeting is looking more likely, markets are currently pricing in 200bp of tightening from both central banks by May 2023, which in our view is too hawkish considering both the eurozone and the UK are looking at very challenging growth outlooks. Conversely, the 200bp of tightening priced in for the same period for the Fed are in line with FOMC’s latest dot plot projections and this doesn't seem exaggerated given the US's lower exposure to global headwinds (like a drop in Russian gas supply).
Second, a sustained dollar depreciation will need to be accompanied by a significant stabilisation and some recovery in global risk assets. That may still prove challenging in a high-interest rate environment, and while markets continue to deal with the incumbent threat of a global recession.
Our view is that even if the dollar did bottom out in the past week, the path to a sustained depreciation remains challenging, and would most likely be very gradual from this point on. And risks of other rounds of dollar strengthening remain very elevated.
Today, the US data calendar only includes existing home sales data, after yesterday’s new home starts figures came in below expectations. Expect limited market impact, and most dollar moves to be driven by non-US factors.
Elsewhere, keep an eye on Canada’s inflation numbers, which are expected to have accelerated further in June and should endorse the Bank of Canada’s aggressive policy tightening.