Here’s Goldman nicely summarising where we are in the FX cycle.
USD: New highs, new why’s. Our broad Dollar index ticked above the October 2023 highs this week.
Relative to last Fall, the latest leg of Dollar strength has been a bit more broad-based and EM-led (in both cases, mostly due to MXN).
Idiosyncratic stories have played an important role, especially in the case of MXN which we think will gradually fade.
But, we also see it as another sign that the Dollar still stands above the ‘challengers’.
But while last year’s strength was inpart due to the prospect of more Fed hikes, recent strength can increasingly be attributed to the lack of Fed cuts.
The US real rate advantage and strong as set returns continue to make the Dollar a high bar to beat, and this could also be partially responsible for the continued drift higher in the key Asia FX crosses.
And now election risk has given the currency additional support as well.
Beyond the currencies that got ‘carried away’, we also think political uncertainty could continue to weigh on the Euro somewhat even if the French election delivers a more benign outcome for spreads.
More importantly, the Dollar has started to respond more clearly to US election risk.
We think this can continue. At a minimum, the approaching election should continue to cause a retrenchment in cross-border portfolio flows even if global growth becomes more balanced.
And, we continue to think Dollar upside is the most reliable market response to a Republican outcome, which is consistent with the market response to changes in prediction markets during the debate this week (Exhibit 1).
We are not necessarily concerned that the market moves have been relatively contained so far—this is normal, the policy outlook is still uncertain, and there are many offsetting factors in FX.
But we still think that the Dollar should stay on the front foot as the market focuses more on tariff risks.
Next week’s payrolls report will be an important policy marker, especially as our economists have cautioned that the labor market is approaching an ‘inflection point’ where further weakness would be cause for concern, but this is a narrow path for substantial and sustainable Dollar weakness, especially in the current environment.
Makes sense to me. It’s hardly to think of a bigger loser from Trumpian White House than the Australian economy as tariffs sink China.
