Fundamental bias: Neutral

1. Developments surrounding the global risk outlook.

As a safe-haven, demand for USD diminished from the middle of 2020 as the market’s attention shifted away from the pandemic and towards an expected global synchronized recovery and a reflation environment (both of which is usually Dollar negative). However, global economic data surprises have been on the decline and will struggle to surprise to the upside, which means the reflation-induced downside in the USD could be running out of steam.

2. The Monetary Policy outlook for the FED

Apart from global growth expectations, a key driver for the market’s negative outlook on the USD was the Fed’s ultra-easy policy stance, which have downplayed price pressures as transitory, and combined with the AIT framework has so far taken the sting out of upside CPI surprises. This initially saw participants pushing back against normalization expectations. However, at the June policy meeting, the bank announced that they have officially begun their tapering discussions, and also acknowledged that recent price pressures have been much higher and faster than they initially expected. The big adjustment in the Fed’s Dot Plot for 2023 also revealed a big chunk of FOMC members changed their mind about when they see rates moving higher, with 13 members projecting a first hike by 2023 from the previous number of 7 members . Thus, the June meeting showed a far less dovish bank. Fed Chair Powell didn’t offer any materially new info with his semi-annual testimony and stuck to his dovish tone.

3. Real Yields

Despite the most recent divergence between the Dollar and US real yields, the correlation between the two has been one of the key short-term drivers from the start of the year. Given how low real yields have recently been trading we think it could be a struggle for them to continue to push meaningfully lower, especially if more “peak inflation” narratives come into play as YY base effects see some easing of recent price pressures. Remember, real yields can still go up even if nominal yields move lower, as long as inflation expectations go down faster.

4. Economic Data

With the current summer liquidity and the fundamental neutral outlook for the USD, we continue to look towards the key incoming economic data points as the most like drivers for the Dollar in the short-term (apart from risk sentiment of course), but the main highlight in the week ahead will be the FOMC policy meeting on Wednesday.

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