Turbulent Times for Currencies: USD Dominates, SEK Shines

FX Daily: King dollar, queen krona

The dollar is finding more strength thanks to a soft risk environment and attractive real rates after the bond selloff. We now see downside risks for EUR/USD potentially extending to 1.02 in a bond sell-off acceleration. SEK is emerging as a big outlier, and we suspect Riksbank FX hedging is behind that, watch for action around 10:00 am BST this morning.

 

USD: Unstoppable strength

The dollar is enjoying another widespread rally, shrugging off yesterday’s unconvincing US consumer confidence figures while being boosted by a round of defensive re-positioning amid a deteriorating risk environment. Furthermore, the recent treasury selloff has kept fuelling the real rate attractiveness of the dollar, reinforcing the greenback’s role as the go-to currency in the current market’s environment.

Federal Reserve speakers have also thrown some hawkish comments into the mix. Neel Kashkari confirmed his notably hawkish stance saying that one more hike is needed even in a soft-landing scenario, and Michelle Bowman has also pointed in the direction of more tightening. Market pricing has, however, remained stuck in a less hawkish position than the recent dot plot projections – less than a 50% chance of another hike this year and the effective rate being cut to 4.67%.

So, there are two lingering upside risks for the dollar stemming purely from the rate market: one being generated from higher longer-dated yields, one from a potential hawkish repricing of short-term rate expectations upholding short-term swap rates. We discuss those risks from a EUR/USD perspective in this article, where we conclude there is more room for a USD rally coming from back-end treasury underperformance rather than another big move in USD short-term swap rates. That’s because the gap between the December 2024 Fed Funds rate market pricing and the 2024 dot plot is much smaller compared to what it was back in June (and throughout the summer).

Today, the US calendar includes durable goods orders for the month of August and another speech by the arch-hawk Neel Kashkari. Fed Chair Jerome Powell will participate in a town hall tomorrow, although it is unclear whether he will touch upon monetary policy issues. The next level to watch in DXY is the 106.82 November 2022 highs, although we have seen the index rise comfortably through key levels, and upside risks now extend to the 107.00/107.50 area should the US bond market sell-off accelerate further.