Deutsche with a useful note.
We argued last month that the dollar has seen the high for this cycle, with our EUR/USD year-end forecast at 1.05. With these levels reached, what now? To start with, it is important to understand why the dollar has weakened so sharply in recent months: in our framework it is all about the dollar’s safe-haven risk premium. China zero Covid, European energy and US inflation/Fed hawkishness all drove a massive increase in the dollar risk premium throughout the year. Those three risks marked a definitive peak in November, in turn allowing for a sizeable USD turn. The dollar’s previously huge risk premium now looks far less stretched (chart 1), also accompanied by a shift in speculative positioning to neutral (chart 2). The question now is can the USD embark on a more sustained downtrend? Not yet is our answer.
First, from a market perspective there is no signal that the dollar’s anti-risk parity regime is changing. The USD continues to behave as the perfect hedge to a long bond/equity portfolio with little pressure on the market’s dollar cash allocation to shift as it is fulfilling its intended purpose (chart 3). Second, to become confident dollar bears we need to have a strong view that global macro conditions are shifting from a stagflationary to a reflationary environment. On our yield curve framework this would equate to a US bull steepening driven by real rates (chart 5) and a convincing low in equities (chart 4). Both metrics have been important dollar bearish markers in the past. Third, we would need to believe that a shift in Fed bias towards easing is coming soon, eroding the dollar’s position as a high-yielding currency. The dollar has historically never embarked on a big downtrend when it is a high yielder (chart 6).
