Time to short the US dollar?

Time to short the US dollar? Not yet but the time is coming supported by the fact that Goldman has turned bullish. It has been wrong on a weak DXY for so long that this can only be bearish for prospects.

USD: Tightening pain = Dollar gain. Fed Chair Powell delivered a relatively hawkish speech at Jackson Hole, with three notable points for markets. First, he mentioned that while there are ‘unfortunate costs of reducing inflation’ that will bring ‘some pain’ now, a lack of price stability would mean ‘far greater pain’ later on. Second, he explicitly referred to the ‘successful Volcker disinflation’ and the need for ‘a lengthy period of very restrictive monetary policy’ to bring inflation back down to target. Third, his brief comments focused primarily on inflation with relatively little reference to the downside risks to growth. Overall, while the main communication from the Fed has not changed, in our view—i.e., that there is a clear desire to slow the pace of hikes, but the near-term path will depend on the ‘totality of the incoming data and the evolving outlook’—the implicit message appears to be that the Committee viewed the period of financial conditions easing following the July meeting as counterproductive. The focus will now shift towards the upcoming US data releases between now and the September FOMC meeting, in particular the payrolls report on September 2 and the CPI report on September 13. While the Fed remains unsure of whether the data will allow a slowing of the pace of hikes next month (especially in the context of the latest comments from other Fed officials), rising recession risk in Europe on the back of the sharp rally in natural gas prices and the slowdown in activity already under way (see the August flash PMIs) means that the Dollar still looks like the clearest long in the near term.

AUD: Catching its breath. Since early April, the Australian dollar has weakened by ~9% against the US dollar despite the support of positive terms of trade shocks. AUD’s decline was driven primarily by deteriorating risk sentiment amid rising expectations of a faster pace of monetary tightening in the US, alongside rising global growth concerns (Exhibit 3). Over the medium term, there are some macroeconomic tailwinds for the Aussie that could help support the currency, including a very strong trade surplus driven by strong prices of key exports from grains to metals and coal/LNG. However, despite a fresh round of Chinese stimulus spending that could boost China’s demand for Australian commodities, downside risks to China (and global) growth remain in focus and over more tactical horizons we remain cautious on AUD vs USD.