US and in particular European equities aren’t rebounding as fast as Japanese stocks, but global risk sentiment is indeed stabilising, which leaves room in FX to realign with the changes in rate spreads. The US Dollar (USD) is in a substantially weaker position than 10 days ago and is looking at an imminent decline against pro-cyclical currencies, ING’s FX strategist Francesco Pesole notes.

The USD is in a weaker position than 10 days ago

“From a purely macro angle, markets remain cautious about big risk-on rallies before the key US CPI risk event (next Wednesday) is cleared. That said, a stabilisation after the big correction around the weekend should be enough for most FX pairs to start reconnecting with rate spreads and fundamentals.”

“From this perspective, the dollar looks vulnerable. We believe markets may be reluctant to take the year-end Fed policy rate much above 4.50%; that’s because 100bp of easing is probably linked to US macro, with anything extra (which has now been priced out) linked to expectations for some sort of intervention by the Fed to help the stock market.”

“That means the rebound in USD 2-year OIS rates to 3.75-80% may struggle to find much more momentum, and the dollar may be left with a short-term rate advantage around 40bp lower compared to just 10 days ago. We expect this will drive the dollar lower against most pro-cyclical currencies amid a potential further stabilisation in risk sentiment and a lack of market-moving data this week.”