US Dollar: Upside risks as Fed stays restrictive – BBH

Brown Brothers Harriman’s (BBH) Elias Haddad notes that the Dollar Index (DXY) has rallied to its highest level since early April as markets react to shifting Iran war sentiment and firmer United States (US) data. Haddad argues resilient US growth and April Personal Consumption Expenditures (PCE) Price Index should support a more restrictive Fed stance, allowing DXY to overshoot its 96.00–100.00 range despite any improvement in risk sentiment.

DXY seen overshooting recent range

"The global stock market rally stalled, bond yields ticked up, and the dollar index (DXY) staged a kneejerk rally to its highest level since April 7.

"Regardless, risk-on sentiment should remain supported because both sides are still talking to work out a deal that would ultimately reopen the Strait of Hormuz. In our view, DXY can overshoot the upper end of its nearly one year 96.00-100.00 range. Resilient US economic activity in both absolute and relative terms outweigh the drag to USD from a potential improvement in sentiment tied to the Iran war."

"The PCE print is expected to reinforce the pricing for a more restrictive Fed stance and underpin a firmer USD. Both headline and core PCE inflation are seen overshooting the FOMC’s 2026 projection of 2.7%. Headline PCE is seen rising 0.5% m/m or 3.8% y/y vs. 0.7% m/m or 3.5% y/y in March."

"Nevertheless, the center of gravity on the FOMC has shifted from an easing to a more neutral bias raising the risk that Warsh becomes the first modern Fed chair to be outvoted on policy. Even dovish-leaning Fed Governor Christopher Waller pumped the brakes on cuts last week highlighting “I can no longer rule out rate hikes further down the road if inflation does not abate soon.”"

"We also get a fresh update of the Atlanta Fed GDPNow model that will incorporate today’s April PCE, durable goods orders, and new-home sales. As of May 21, the Atlanta Fed GDPNow model estimates annualized real GDP growth of 4.3% in Q2 vs. 2.0% in Q1."

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