USD: Yield spreads and policy risk cap upside – MUFG

MUFG’s Lee Hardman argues the US Dollar’s response to the Middle East-driven energy shock has lost momentum. He cites lingering optimism about a relatively quick end to the conflict, a higher US policy risk premium, and yield spreads moving against the Dollar as key factors. Fed officials signal rates may stay on hold while markets remain undecided on the next move.

Policy risk and rates temper Dollar gains

"The US dollar has strengthened in response to the energy price shock triggered by the Middle East conflict but has noticeably lost upward momentum in recent weeks."

"Firstly, it could reflect lingering investor optimism that the Middle East conflict and will end soon and is quickly followed by the re-opening of the Strait of Hormuz."

"Secondly, US dollar strength could have been dampened recently by the pricing in of a higher US policy risk premium to reflect fresh uncertainty triggered by the Middle East conflict although it is difficult to quantify."

"Thirdly, the short-term yield spreads have been moving sharply against the US dollar over the past month."

"US rate market pricing is also currently sat on the fence over whether the next policy move will be a cut or a hike."

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