What has driven the sell-off in the US dollar this week?

Risk appetite continued to recover on Thursday, with the US dollar once again giving back some of its recent advances against most major and emerging market currencies. Since the end of last week, the US Dollar Index has fallen by almost 2%. EUR/USD has rebounded back towards the 1.06 level, helped on its way by some hawkish comments from ECB members and heightened expectations that the bank will raise rates by 25 basis points at its July meeting.

Sterling has edged back to just shy of the 1.25 mark, while all other G10 currencies have also posted gains against the greenback in the past week. While there has not necessarily been an obvious single catalyst for the rally, we largely attribute the move lower in the dollar to the below:

1) Market takes a breather

As tends to be case following a prolonged rally, we may simply be seeing investors unwinding their long positions, and booking profits following the recent sharp move higher in the dollar.

2) China’s COVID-19 headlines improving

Macroeconomic data out of China has taken a serious turn for the worst in the past few weeks, but headlines on the covid front have, at least, shown signs of improvement. Shanghai is set to ease its lockdown measures in the coming weeks, as new case numbers in the country fall sharply (down around 80% from the recent peak).

3) Global macroeconomic data holding up well

Recent data out of the major economic areas suggests that calls for a sharp slowdown in growth, and possible recessions later in the year, maybe a slight overreaction. The G3 PMIs have remained firmly in expansionary territory (indeed all three are printing above the level of 55).

Consumer spending also appears to be holding up well, with activity buoyant despite the recent surge in inflation. We actually think that the global economy will probably hold up slightly better than some economists expect this year.

4) Market has already fully priced in Fed tightening

The lack of reaction in the US dollar to the very hawkish comments from FOMC Chair Powell earlier in the week, who said the Fed may have to raise interest rates above the ‘neutral’ level this year, provides further proof that it will be very difficult for the central bank to exceed market expectations this year.

There won’t be too much in the way of major market-moving news today, aside from this morning’s UK retail sales figures that will be skewed by the base effect following the removal of lockdown measures in April 2021. A speech from ECB member Lane later in the day may be worth watching, although activity is likely to be largely driven by the factors listed above.