J.P. Morgan On The USD
The US Bank weighs in on the USD outlook, post its strong run higher. It maintains a medium term bullish stance, but tactically reduces some longs given the recent rally, see below for more details.
J.P. Morgan: "The USD’s six week bull run is consolidating, in line with historical sidewinding patterns following strong surges. Concerns around additional dollar headroom given the outsized jump in IMM USD positions are valid, but also need to be tempered by the looseness of peak CFTC positioning as a contrarian USD signal. Of greater import is the maturation of US - RoW forward rate pricing, that has eliminated the dislocation of fewer cuts being priced for cyclically and structurally challenged G10 currencies relative to the USD. The neutralization of stark early’24 asymmetry in USD rates/FX valuations and positioning is running into a pivotal period of US dataflow that carries almost binary risks for the Fed cycle this year. Without a clear edge on calling the latter, a tactical reduction in USD length is prudent notwithstanding medium term bullishness.
A dovish BOJ hold puts paid to hopes of a monetary policy short-circuit for Yen weakness, but intervention threat is likely to render USD/JPY buying a noisy proposition. USD policy: FX policy risks around the election have resurfaced. UST cannot weaken the dollar sustainably through direct intervention given limited USD assets. Intervention would be more effective if done in conjunction with easier monetary policy and global coordination.
Trades: Reduce USD longs via USD/CHF cash, but keep USD/CHF call spread. Enter NOK/SEK cash longs. Take-profit-stop hit in long SEK/CZK cash. Hold USD longs vs GBP, CAD, CNH, EUR into the FOMC meeting. Keep CHF/JPY digital put.
Dollar fatigue? The broad dollar is taking a breather after 3%+ near-straight line gains over the past six week (DXY basis), and has lost ground to every G10 currency over the past week except the JPY. The good news for USD bulls like ourselves is that such an impressive rally does not tend to be followed by imminent trend reversal. That the norm is for the greenback to sidewind in a consolidatory pattern over the next 2-3 months following major surges; notable exceptions to the rule resulting in 4%-5% subsequent drawdowns either involved material ex-ante valuation froth in the DXY vs. rate spreads (2.5%+ misalignments), or policy short-circuits (2020, 2022). Neither holds true / appears likely at this stage: 2024’s USD bull run has merely followed the contours of the US - RoW real rate gap with no signs of speculative excess, and the kind of ‘Fed pivot’ mania that triggered major bear-reversals in 4Q22 and 4Q23 looks conspicuous by its absence after a long string of chastening upside surprises on US growth and inflation this year."