USD to strengthen further through this phase of 50bp rate hikes but beginning to overshoot – MUFG

The US Dollar Index recorded another gain last week – the fourth consecutive of gains. The primary driver remains rates divergence and hence the FOMC meeting will be key. In the view of economists at MUFG Bank, the US dollar may be entering overshooting territory, therefore, the greenback’s strength may be reaching its limit.

USD upside risks persist but entering overshoot levels

“Fed Chair Pow ell is certainly likely to talk very tough on tackling inflation risks – it will be the first 50bp rate increase since May 2000 – and Pow ell and the FOMC w ill not want to undermine expectations of further 50bp moves at this stage. While such hawkishness may not lead to big market rates moves, it should nonetheless be supportive for the dollar.”

“We see scope for the US dollar to strengthen further through this phase of 50bp rate increases (May/June for sure) but the scale of strength from here is certainly more limited now. Our DXY-weighted 2yr spread is at the same level as at the start of April suggesting some topping out that could start to play a role at curtailing further notable US dollar strength from here.”

“Leveraged funds’ long USD positioning is relatively light and with the Fed set to endorse market pricing at this early stage of tightening in circumstances of negative risks abroad, further USD gains are likely over the short-term.”