US Dollar: Still no signs of peaking

China’s Zero-Covid won’t disappear overnight

While there was some speculation this week that China could start to consider ways to part with its Zero Covid policy, none of that has been confirmed by the authorities. If we do see the China economy open up, that suggests commodity prices could bump higher as China demand comes back online. That should support the commodity currencies such as AUD and NZD, and also bring in a recovery in the Chinese yuan. But any massive shifts or significant steps to open up the economy are unlikely in the near term, and these will likely remain subtle at best. A dynamic Zero-Covid policy is likely to stay for now, potentially with some flexibility around quarantine requirements or PCR tests.

Recession risks will bring safe-haven flows to the USD

The US economy still remains in a position of strength, with a strong labor market and significant household savings. This, in comparison to rising recession fears in the EU and the UK, suggest that capital flows will continue to be fuelled towards the safety of US assets. Even if we see a mild recession in the US, markets will be scrambling for liquidity which is usually found in US dollar or the US Treasuries. A temporary peak may be seen in the USD later in Q4 or early Q1 as Fed’s upward pricing reaches a peak, but still, a turnaround in the USD will be slow and stretched.

What causes the turnaround?

In the short run, a peak in USD would be a result of a near peak in pricing in the Fed rate path. But a more sustainable trend lower will have to wait for US economic data to show a materially different trend. Say core PCE down to 0.1-0.2% MoM levels or labor market materially cooling with NFP gains down to about 100k or so.

Asian FX to continue to face headwinds

Another leg higher in the USD will mean further pressure on Asian FX, especially the Chinese yuan which is facing policy divergence to the Fed and a slowing economy at home. Other tech-exposed currencies like the Korean won (KRW) and Taiwanese dollar (TWD) may be under greater pressure as well, although relative resilience can be expected for the safe-haven Singapore dollar (SGD). The Indonesian rupiah (IDR) will also likely be supported if Bank Indonesia adopts a fast pace of tightening, as a favourable current account situation also lends support.

Investment inspiration to consider

Long USD and short risk assets is perhaps still the most favourable strategy. We previously listed out tools that can be used to go long US dollar here. In the FX space, this can be traded using options as well with potential short positions on GBP, EUR, TWD, KRW.

Also, consider that upward pricing of Fed’s rate path from here can mean short-term headwinds for Gold and Silver. We still expect medium-term upside in precious metals, however, as inflation expectations remain anchored higher in the new deglobalized world.

Meanwhile, a lower pace of Fed rate hikes from here could reduce volatility in the interest rate markets, so watch the MOVE index. This could potentially lower the volatility in the FX markets as well. We believe a peak in bond volatility will be the key, and the first sign, for the markets to reverse trend.