US Dollar: Undervaluation flags downside risks – MUFG

Halpenny highlights MUFG’s G10 regression models showing the US Dollar undervalued against most peers, implying risk premia tied to Middle East conflict, inflation concerns and political interference at the Federal Reserve. US-backed Yen intervention and subtle support for broader Dollar devaluation versus Asia could encourage investors to sell the Dollar when sentiment deteriorates.

Risk premia and policy signals weigh on Dollar

"Looking at our short-term regression models across all of G10 reveals an interesting consistency – the US dollar is undervalued versus eight of the nine currencies in the G10 space suggesting some additional risk premium is currently priced into FX that has prompted this underperformance of the dollar. Some factors may explain this. We could be once again on the cusp of a ceasefire deal in the Middle East that may mean the US dollar has priced this scenario more quickly than other markets that is showing up as US dollar undervaluation in our regression models."

"Another factor that could be starting to weigh on US dollar performance is the intervention that took place last week. This was much more meaningful of course due to US involvement and even though the US Treasury chose not to sell the US dollar, its strong support for Japan in attempting to strengthen the yen and weaken the US dollar is telling."

"Scott Bessent also cited the negative implications of an undervalued yen in dragging valuations lower for Asia FX more generally versus the US dollar. Bessent mentioned specifically that the renminbi also could be undervalued. The US Treasury looks to be subtly endorsing a US dollar devaluation versus Asia more generally."

"Finally, the Wall Street Journal is reporting today that President Trump has spoken to Fed Chair Warsh “repeatedly” since he took over at the Fed with “bursts” of calls “several times in a stretch of days” and this will only reinforce the impression of greater political influence undermining Fed independence. The underperformance of the dollar relative to our models likely captures some of those Fed-related risks and the uncertainty over the Fed’s reaction function going forward. That uncertainty is likely keeping yields higher without offering the dollar the usual support."

"Concerns that emanate from Washington over financial market developments will hardly instil confidence in global investors in holding US assets and could herald another spell of increased US dollar hedging like January this year, which would be bad news for the dollar."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)