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FX | Economy

FX Focus - DXY – Has The Dollar Fallen Far Enough?

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Forecast Spot 0 - 3m 6 - 12m Long-term
DXY Index 101.09 104.79 104.52 95.80

*Forecasts as of August 2024.

 

  • The broad-based dollar index (DXY) has fallen more than 4.5% over a two-month period since late June to well below the 102 – 104 range that has held for much of this year. Compare this to the 21 months it took for DXY to drop 7.0% from its peak of 114.10 in late September 2022 to June 2024. So why this sudden sharp drop in the dollar over the past 2 months and are conditions ripe for DXY to stabilize?     
  • There are 2 reasons for the recent sharp drop in DXY:
    1. Fed Chair Powell’s explicit concerns about the deterioration in the US labor market and his determination to steer the US economy to a softer landing through easier financial conditions. These concerns were initially expressed at the August FOMC meeting but made more forcefully at the Jackson Hole Symposium in late August when Chair Powell stated that the cooling of the labor market is “unmistakable” while making it clear that the “the time has come for policy to adjust”. US rates fell sharply and took DXY with it.
    2. Disorderly unwinding of the yen “carry” trade that saw JPY gain a massive 20 big figures (12.5%) vs USD from mid July, driven partly by falling US rates due to Fed Chair Powell’s decisive dovish pivot but also because of the Bank of Japan (BoJ) hiking rates at its July 31st meeting with an accompanying hawkish statement that raised expectations of BoJ potentially normalizing rates at a faster pace.
  • A softer landing for the US supported by Fed rate cuts should be positive for risk assets and negative for the dollar as it shifts flows away from safe-haven FX (USD) to those that benefit from the more positive US (and by implication) global growth story (commodity FX (AUD) as an example). But DXY has already fallen sharply as US rates markets moved to discount an aggressive 100bp in Fed rate cuts to year end at a further 100bp in cuts by mid-2025 to a 3.25-50% Fed Funds.
  • Tactically the risks may now be more 2 way for DXY because
    1. The Fed has yet to validate the pricing of rate cuts discounted in markets and much will depend on the next set of US jobs and inflation data. Recent comments from Fed officials other than Chair Powell suggest not everyone is on board the forceful dovish pivot at Jackson Hole and risks of US rates backing up a bit from current levels have risen
    2. With less than 3 months to the US presidential election, the prospect of rising US – China trade tensions may put a safe-haven bid back into DXY.
    3. Valuations in currencies like EUR now look a bit “rich” due to euro area’s economic momentum slowing once again from the German manufacturing recession and the drop in euro area’s consumer confidence in August for the first time since January. Given the importance attributed to the consumer confidence recovery by the ECB and German Bundesbank, this setback feels important. As a result,  the current mixed global macro settings may warrant more of a tactical rebound in DXY towards the 102 – 103 level before it likely resumes a more sustained decline once US data shows evidence of the US economy heading towards a softer landing. That is likely a story for early 2025 after the US presidential election.

 

DXY Index approaching June 2023 lows

Source: Bloomberg, August 29, 2024

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MARKET SPECIFIC DISCLOSURES

Market Specific Disclosures

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