The USD remains well supported with markets adding to longs ahead of the December Fed meeting. Further gains can be expected given that the Fed will be hiking rates while other central banks will be easing. Concerns about the impact of the already pricey USD could grow from here, however.
Indeed, the Fed narrow USD NEER is now only about 7% from its 2002 highs after appreciating by more than 25% from the 2011 lows. Other USD gauges like DXY, suggest that we are up 33% from the 2011 lows and about 16.5% off the 2002 peak. Our inhouse FX valuation model suggests that, next to CHF, USD is the most overvalued G10 currency with the EUR and JPY ranked as the most undervalued.
Worries about the impact of the strong USD have been rather muted of late. One important reason for that seems to be the Fed itself. Indeed, the FOMC speakers in recent weeks haven't signalled heightened concerned about the recent FX appreciation. That said, with the US manufacturing sector darkening due to lingering export weakness and inflation expectation measures still close to multiyear lows, concerns about the impact of strong USD could resurface before long.
We doubt that such concerns will stop the Fed from tightening in December. That said, excessive and unwarranted USD appreciation can mean that the Fed will be more cautious tightening beyond December.
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