The USD; a magical currency that has the wind to its back

26 במאי 2023

The momentum is to the USDs back and there are multiple core tailwinds supporting the dollars investment case. I would argue that the USD has become somewhat of a magical currency, where we’re seeing safe-haven flows, as well as a cyclical element, where US data has recently been better than feared.

We can see US economic exceptionalism playing out, while US mega-cap tech attracts international capital – this has resulted in the USD becoming the best house in the street – in effect, both the left and right sides of the USD ‘smile theory’ are now working.

Bullish USD technicals

Technically, we saw the USD index (USDX) build from triple bottom support at 100.46, pushing into 104.23 (at the time of writing) and we now eye a push to the top of the YTD trading range and 200-day MA of 105.36 – I see real risks it gets there and the momentum trader in me questions whether to chase at these levels and stay with the trend, or look for a slight dip to initiate.

The rally accelerated on 12 May when the price closed above the top of the consolidation range and upper Bollinger Band, and since then it’s been one-way traffic. We see sell-offs contained and limited by the 5-day EMA, which I would use to define the short-term bias – happy to stay long until the price closes a daily bar below the EMA.

Over the past month, we see the USD gaining vs all major currencies, with the exception of the MXN and the KRW. The biggest gains have been seen vs the ZAR (USDZAR -7.6% MTD), SEK (-5.13%) and NOK (-3.6%). EURUSD is lower by 2.7% MTD and has been at the backbone of the USDX move.

Clients on aggregate are playing the USD for a countertrend and for a short-term bounce and are willing buyers of USDs, notably vs the AUD and NZD. We see 72% of all client's open positions are now held long in both AUDUSD and NZDUSD – I’d expect that skewed position to be pared back on a move back to the range breakdown point in AUDUSD at 0.6580.

China, a key factor behind the USD buying

At the heart of the move in the USD, we must go back to China – USDCNH has been on a bull trend since early May and eyes a move into 7.1000. The weakness in the CNH has impacted the EUR and classic China proxies, such as the AUD and NZD. We see outflows from China’s equity market (through the Northbound ‘connect’) and whether you look at the CHINAH, HK50 or CN50 all indices at YTD lows. Concerns around a resurfacing of COVID, property defaults and clear signs the economic recovery is fizzling out are all weighing on these flows.

Some of this capital has been redeployed to the US, where ‘carry’ (income) is a major attraction and investors are compelled by the relatively higher yields on offer in US rates.

Next Wednesday we get China PMI manufacturing and services data, and this will need to come in above 50 (on the diffusion index) to encourage CNH shorts to cover. Either way, if USDCNH rolls over and heads lower, then I’d expect the USD to find sellers on a broad basis.


Another factor is that US economic data has stabilized and we’re seeing various data points looking better than feared. Various Fed officials offered somewhat hawkish opinions and the Fed pause has been priced out – so we move into a world of the ‘skip’ - where if the Fed leaves the fed funds rate unchanged on 14 June FOMC but offers a strong bias to hike in the July FOMC meeting.

US interest rate pricing has supported the USD

We see 12bp of hikes now priced for the 14 June FOMC meeting – suggesting it is a ‘live’ event and shaping up to offer some reasonable volatility. Looking further out we see the rates market has aggressively repriced from expecting 107bp of cuts by January to now price just 30bp of cuts.

US Core PCE inflation (today at 22:30 AEST) could be influential in this rates pricing, with markets expecting this to come in unchanged at 4.6% - so a number north of this could see rate expectations for June lift further. After that, we look to US non-farm payrolls (2 June) and US May CPI (13 June) – the trifecta of influences for the June FOMC meeting, that could result in a skip or a hike.

Many have also looked at the US 2yr Treasury as inspiration and causation behind the USD buying activity, where we see yields rise from 3.65% to 4.53%. US 5yr real rates (we adjust for expected inflation) have been moving sharply higher and again this represents a higher real cost of capital.

So, what turns the USD around?

• The US debt ceiling takes a negative turn, and we see a far more troubled market and a belief we could see a missed payment around 7-8 June
• A better feel towards China’s markets – a stronger CNH would compel USD selling.
• Below consensus reads in key US economic data, notably on PCE, NFP and CPI.
• A broad move to take profits on US Treasury shorts and USD long positions.

For now, the USD is in beast mode and pullbacks should be lapped up – we see both sides of the USD smile working and supporting a trending market. The exceptionalism story, for now, is real.