U.S. Dollar Outlook: What Clients Want to Know

  • The dollar index (DXY)1 has declined to 98-100 after trading at around 110 at the start of the year, with the price action having decoupled from the correlation with 10-year bond yields.
  • Several factors led to the weakening of the United States Dollar (USD). First, the sharp rise in equity and bond market volatility associated with the April 2 ‘Liberation Day’ prompted an unwinding of the carry-trade, pressuring the dollar lower. Second, global institutional investors, especially Taiwanese insurers holding long unhedged U.S. assets, unwound or hedged these positions, adding downside pressure to the USD. Third, President Trump’s mid-April criticism of the Fed increased investor unease, dampening appetite for US assets.
  • Consequently, Fitch Solutions expects the DXY to trade within 95-100 in the coming months, as these factors continue to weigh on the dollar in the short term. Moreover, the agency anticipates lower growth will lead to roughly 50 basis points (bps) of interest rate cuts, while a widening fiscal deficit, though loosely correlated, may also weaken the dollar.
  • However, downside risks are somewhat limited compared to several months ago. The agency sees little chance of the DXY falling significantly below 95, contrasting with other forecasts that target levels of 90 or lower. The decline in the DXY is constrained by the belief that trade-related volatility has peaked, reducing downward pressure.
  • That said, while the US dollar’s share of global reserves has decreased over the past decade, this does not indicate a rejection of the USD. Instead, reserve holdings have diversified into a basket of currencies, including the Australian and Canadian dollars, sterling, the Chinese yuan, and the Japanese yen. This shift reflects a more globalised economy where companies, investors, and banks manage assets and liabilities across multiple currencies.

    ______________________________________________
    1The U.S. dollar index is a measure of the value of the U.S. dollar relative to a basket of foreign currencies. The U.S. dollar index is currently calculated by factoring in the exchange rates of six foreign currencies, which include the euro (EUR), Japanese yen (JPY), Canadian dollar (CAD), British pound (GBP), Swedish krona (SEK), and Swiss franc (CHF).

(Source: Fitch Connect)