Synopsis: Despite its historical strength and the ‚USD smile‘ framework, the USD’s recent subdued performance has left market observers questioning the continued applicability of this model. Credit Agricole delves into the factors affecting the USD’s momentum and highlights the potential paths for the currency moving forward.
Key Takeaways:
- Synchronized G10 Rates and Yields: One of the chief factors that may have hampered the USD’s surge is the synchronized movement of most G10 rates and yields. This synchronous movement has marginally improved the USD’s relative rate appeal, making it less of a standout amidst its peers.
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Fed’s Signal on Financial Conditions: The Federal Reserve has hinted that a combination of higher US rates, increased yields, and risk aversion could dampen the urgency for additional rate hikes. This signaling potentially curbs aggressive bullish sentiments for the USD.
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Rising Foreign Portfolio Outflows: The US has witnessed a surge in foreign portfolio outflows from its fixed income markets. This trend is attributed to deteriorating fiscal prospects in the US coupled with diminishing FX reserves. Such outflows can act as a drag on the USD’s strength.
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Overhang of USD Long Positions: An accumulation of long positions on the USD could be indicating market saturation, making further bullish movements harder to achieve.
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The ‚USD Smile‘ Framework: While recent events have made market participants question the relevance of the ‚USD smile‘, Credit Agricole believes it remains a pertinent FX market model. The primary channel that could bolster the USD, under this framework, is a sudden surge in risk aversion leading to a robust inflow into US safe-haven assets.
Conclusion: While recent dynamics have posed challenges to the USD’s dominant trajectory, the ‚USD smile‘ remains a relevant tool to understand potential currency movements. The USD might find significant support if global markets witness heightened risk aversion, channeling more investments into safe-haven US assets. Investors should be vigilant of global risk sentiments to gauge future USD movements.
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This article was written by Adam Button at www.forexlive.com.