USD firm in the near term but medium-term bearish – Unicredit

Research Team at Unicredit, suggests that as the market digests the hawkish FOMC shift, the USD is likely to remain firm; but the re-adjustment of expectations towards a more normal tightening cycle is not enough to revive the “divergence trade”.

Key Quotes

“The hawkish FOMC minutes were swiftly reflected in market expectations by pushing the US rate strip higher and lent further support to the recent rebound in the US dollar: the TW USD index is now nearly 2.8% higher MTD. As the market digests this hawkish shift, we expect the USD to remain firm in the near term. Having said that, the latest price action has not altered our medium-term bearish view on the USD: first, a durable revival of the “divergence trade” requires a far more aggressive FOMC, rather than the re-adjustment of market expectations towards a more normal tightening cycle; second, there is no empirical evidence corroborating USD strength during a Fed rate-hike cycle; and lastly, even after the recent pullback, the USD remains on a bearish trend, and is 4.5% weaker YTD.

This is why we do not view the EUR-USD retreat back to 1.12 as the basis for a trend reversal. We also think that firmer preliminary EMU PMIs for May, as well as higher ZEW and IFO surveys in Germany this week, would limit any short-term downside potential.”