The dollar's recent surge is a fascinating development, and it's worth delving into the factors driving this trend. In my opinion, the market's pricing of the Federal Reserve's tightening policy and the tech-led sell-off in risk assets are the primary culprits. However, what makes this particularly intriguing is the interplay of these factors and their impact on various currencies and markets. Let's explore this further.
The Dollar's Dominance
The dollar's broad support is a result of the market's pricing of the Fed's tightening policy. The US jobs report has raised expectations of second-round effects from the energy inflation shock, leading to a close to 30bp of Federal Reserve tightening this year and 50bp by the second quarter of 2027. This pricing is a significant factor in the dollar's strength, as it suggests a more aggressive monetary policy stance.
However, what many people don't realize is that this pricing may be too aggressive. The market's expectations of Fed tightening have caught an investor base overweight in equities and emerging markets, leading to a tech-led sell-off. This sell-off is particularly notable in benchmark tech names, as investors clear room in portfolios for the SpaceX IPO and other upcoming IPOs.
The Impact on Currencies
The Swedish krona and the Israeli shekel are the most tech-sensitive currencies in the G10 and EM spaces, respectively. The risk-off mood and the unwind of risk assets are normally dollar-positive, and this is likely to add weight to US Treasuries. Additionally, the geopolitical backdrop is shifting dollar-positive, with the Iran-Israel conflict and the potential for further tensions.
The ECB and the Euro
The euro is under pressure due to the dollar's surge and the ECB's potential hawkish stance. The ECB is widely expected to raise its deposit rate by 25bp to 2.25% this Thursday, and a hawkish-sounding ECB will maintain the view that it will hike again in September. However, the risk is that eurozone manufacturing activity data may start to deteriorate after hoarding/inventory building earlier this year around the uncertainty of the Gulf conflict.
The BoE and the Pound
The Bank of England is expected to avoid tightening this year, and the market expects relatively little of the Bank this summer. However, the BoE's inflation expectations data gives some confidence that second-round inflation effects are less likely. In theory, the euro-pound should be trading higher if the BoE is dragging its feet on tightening, but the pound is generally seen as a pro-risk currency with a large financial sector, meaning that it generally underperforms in a risk-off environment.
The CEE Region
The CEE market saw strong hawkish repricing last week, not only due to the US job data. Market pricing has returned to almost three rate hikes in Poland and almost four rate hikes in the Czech Republic in the one-year horizon. However, the stronger US dollar is setting the direction for FX in CEE, and the region is following the EM sell-off. The Polish zloty appears to be the most vulnerable currency in the region, given the dovish National Bank of Poland story.
In conclusion, the dollar's recent strength is a fascinating development, and it's worth exploring the factors driving this trend. The market's pricing of the Fed's tightening policy and the tech-led sell-off are the primary culprits, but the interplay of these factors and their impact on various currencies and markets is what makes this particularly intriguing. As we move forward, it will be interesting to see how these factors continue to unfold and shape the global financial landscape.
