The US dollar continues to gain strength, driven by heightened geopolitical risks, particularly concerning Ukraine, as noted by MUFG EMEA. This uptick reflects a broader trend of investors seeking safe-haven assets amid uncertainty, which has implications for FX markets. Per the full note, the dollar's recent performance underscores the market's sensitivity to political developments, including potential shifts in the US administration and upcoming ratings announcements in France. With no major events on the horizon, the dollar's trajectory may remain influenced by these geopolitical factors.
What the desk is arguing
The strengthening of the US dollar this week is strongly tied to heightened geopolitical risks, particularly surrounding Ukraine. As political dynamics shift both domestically and in Europe, the dollar tends to perform well, acting as a safe-haven asset amidst uncertainty.
Derek Halpenny from MUFG highlights the potential implications of changing political landscapes, such as Trump’s cabinet appointments and French political risk ahead of significant credit ratings announcements. The response from market participants thus favors the dollar, establishing it as a resilient choice against fluctuating global sentiment.
Where it sits in our coverage
Our consensus target for the US dollar currently sits at 1.075, reflecting a bullish stance on its trajectory amid ongoing geopolitical stresses. This aligns with firm spreads indicating the demand for the dollar as a safe-haven during periods of instability.
The market perspective appears divided, with some firms remaining steadfastly bullish while others express caution about the dollar’s overvaluation. Aligned with our outlook, jpmorgan forecasts a target of 1.10, supporting the notion of continued strength for the dollar through March 2026.
Conversely, bofa warns of potential retracements, asserting a target of only 1.04 by March 2026, reflecting a contrary view against the prevailing sentiment on the dollar’s strength.
01US dollar strengthens due to geopolitical tensions.
02Political shifts in US and Europe impact FX markets.
03Market sentiment favors the dollar as a safe-haven asset.
Market implications
The strengthened US dollar could deter exports and impact international trade dynamics as it becomes increasingly expensive for foreign buyers. Conversely, this move may bolster investor confidence in US assets, driving capital flows back to the market.
Risks to this view
Key risks include an escalation of geopolitical tensions that may lead to market volatility, as well as domestic political developments that could alter the economic landscape considerably. Should political stability return to Europe, there may be pressure against the dollar's current strength.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Helpenny, Head of Research, Global Markets in Europe and International Securities. It's Friday, the 22nd of November, 2024. And joining Derek to pose some questions on the financial market themes for the week ahead is Jack Greenslade from the Global Customer Marketing Group.
The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients. Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi, Derek, how are you?
I'm good, Jack, and you? Yeah, I'm well, thank you. It's been a very, very busy day today, but there we go.
Indeed. So the first thing I wanted to really discuss with you is that big risk-off move we've seen and how big the dollar's been over the last few days. What can you tell me about what's been occurring in Ukraine and some of the other geopolitical risks that we've seen?
Yes, I think there's so much out there in terms of the drivers and the dynamics in the markets. Obviously, we've seen some escalation in terms of the missiles used by Ukraine and then from Russia. So I think there's definitely been some increased concerns of an escalation, obviously, and what that might mean.
Euro obviously gets hit pretty significantly on any kind of potential escalation. Although, obviously, it doesn't have the same reverberations as, say, for example, when the war started and the type of energy shock that we had then, the kind of energy supply dynamic has changed. And in that sense, it doesn't change that element in terms of how the markets are reacting, but it's a general risk-off.
And I think it's being reinforced by other factors, in particular on Euro. One interesting aspect is, I guess, the Japanese yen. We've obviously gone through a period of time in which the yen's risk of status has been significantly undermined because of global inflation.
And you could certainly make the case, and we would, and we've highlighted in some of our research, that with the Fed now in rate-cutting mode, the chances of the more traditional yen response to risk-off is definitely much higher. And we did see a pretty notable drop in dollar-yen when the first phase of escalation took place this week. So it does suggest that the yen would or could behave in a more risk-on, risk-off fashion like we've been used to.
So looking at the screens now, Jack, the yen is up. It's stronger against all of the yen crosses. It's close to unchanged versus the dollar, but of course, the dollar is broadly stronger across the markets as well.
So yeah, I've mentioned those other factors. We know what those are. Weak data in Europe today, Trump, US politics, all the rest.
So there's plenty of themes there for sure. Yeah, exactly. And I guess one of the other factors has been the appointment of Donald Trump now being elected as well.
And of course, he's now picking his cabinet picks. So what are you looking at there and how might it affect the dollar? Yeah, look, I think the most interesting thing I would say on all of this is that we've had a lot of positions that have now been filled.
And even with Matt Gaetz stepping down as the candidate for Attorney General, Trump has been pretty quick to nominate somebody else, Pam Bondi, who's got to be, it seems, as disruptive as Matt Gaetz. So the speed in which he's done that tells you that he's well prepared for the potential of somebody stepping down or not getting through the Senate. And probably his second, third, fourth choices are all disruptors like a lot of the candidates that we've had so far.
But I think when it comes to the key economic positions for the financial markets, there is certainly signs in terms of those positions not being filled as quickly. It does suggest that when it comes to that loyalty over experience that is evident in all of the other candidate picks, or most of the other ones, that when it comes to the economics markets related picks, he's perhaps considering experience over loyalty or certainly more weighing up the two. And Howard Lutnick is, the dollar strengthened when Lutnick was announced as the Commerce Secretary.
Probably not so much that announcement in itself, but the fact that the office of the US Treasury representative has been brought in under the Commerce Department tells you that when it comes to trade policy, that US trade representative position may be less important now, and Commerce Secretary could be the position in which we get those policies driven forward. And Lutnick, when you look at his Twitter profile or his ex profile, as we should be calling it, he's a disruptor. And he's going to be probably pretty aggressive in pushing through what Trump wants.
So I think the dollar strengthened in the back of that. I think Treasury Secretary position, obviously, we still need to know who that is. Kevin Warsh and Mark Rowan seem to be gaining in traction in terms of potentially getting that position.
I think, obviously, if it was Kevin Warsh, given he's ex-Fed, and given the fears in the markets about Trump undermining the independence of the Fed going forward, a pick of Kevin Warsh would maybe diminish those risks of any kind of threat to Fed independence, because Kevin Warsh has been pretty clear in terms of being pro the importance of an independent Fed. So that might help to reassure the markets on that point. So, yeah, I think Kevin Warsh would be good for the markets.
But I think on trade, I wouldn't read too much into that position in terms of where we go with trade. Obviously, that position would need to be relatively supportive of trade policy. But it looks like it's going to be Howard Lucknick and the Commerce Department driving that.
Yeah, of course, he's got the red sweep. Do you think that markets are overly optimistic about what he can deliver? Yeah, it's a good question.
It is pretty surprising or, yeah, I think surprising in that when you look at the dollar performance as of right now, compared to the beginning of October, which is when the Trump trade began. And in actual fact, if you go back to 2016, it was pretty much a similar point in time when the dollar started to strengthen on the possibility of a Trump win. And the dollar move, 1st of October to today and the equivalent in 2016, pretty much up the exact same amount, just over 6%, even though Trump's win in 2016 was a much bigger surprise.
So what that tells you is even though the markets were less surprised about Trump winning in 2024, there's a lot more focus on more aggressive trade policy from possibly day one. And I think that's a big factor as to why the dollar has strengthened to where it is. Now, equity markets have performed a little bit less well this time compared to 2016.
And yeah, the rates market as well, there was a slightly bigger move in 2016 versus today. But there is definitely still optimism in the markets in terms of what Trump is going to deliver. But for us, I'm certainly a bit skeptical of the ability of Trump to deliver non-inflationary growth, like what happened in his first term.
The obvious difference is that we're in an entirely different world post-COVID and post the largest global inflation shock since the late 70s, early 80s. Breakeven rates are 75 basis points higher today compared to 2016. Debt levels, publicly held debt in a 10-year period between 2014 and 2024 is up 122%.
And inflation obviously today, actual inflation is higher than where it was in 2016. So I think the ability to boost growth while keeping inflation stable is very questionable. And I think there's disappointment to come in that context.
And that's certainly not priced into the markets at this point in time. Yeah. And just turning from one effect of an election to the other side of the world, really in Europe, we've had the breakdown of the German coalition.
And now there's risk that there's a French election upcoming as well. Do you think this is weighing on the Euro at all? It could be.
Yeah, I think it's certainly coming back into focus, driven by the OAT bond spread, which has jumped this week and we're back up towards the highs of close to 80 basis points. We're trading about 78 basis points today. So this is stemming from essentially a greater risk that maybe National Rally and Marine Le Pen will side with a no confidence motion.
They're certainly speaking that way at the moment. So the revenue side of the budget was rejected in Parliament. And Michel Barnier has indicated that therefore he's likely to have to push it through under Article 49.3.
And that's going to trigger a no confidence motion by the left. And then it's down to RN and Marine Le Pen and Jordan Bardella on whether they support that. And the communication certainly suggests there's a greater likelihood of that.
I'm still not convinced this could be all part of the political gamesmanship, if you like. And at the end of the day, there's a lot of benefit for National Rally and Marine Le Pen to be seen as the party of stability, of not the party causing disruption by essentially collapsing the government at a time when you can't have, under the law, you can't have an election until June 2025. So it would leave the situation pretty messy.
So they could, again, abstain when it comes to a no confidence motion. But the risks have risen. And that's reflected in the OET bun spread.
And in an environment where the euro sentiment is so negative, we've had very weak PMI data today, the market's now looking at 150 basis points of rate cuts over the next 12 months. We're only looking for about 65 in the US, 65 basis points. So there's a big divergence play in there now as well.
And yeah, you'd have to say, certainly next week, it could become a bigger focus. We've got the S&P ratings announcement next Friday. I doubt they'll downgrade France at this very sensitive moment.
They've already downgraded them earlier this year in May, and then they downgraded the outlook in October. So they've already taken action this year. And I think they'll probably hold off on this occasion.
But the markets might get nervous going into the end of next week on the potential for a downgrade. Okay. Well, that's all we've got time for now.
But thanks so much for speaking to us, Derek. Indeed. Thank you, Jack.
Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe and contact your MUFG sales rep for more information. Come back next week for more insights from the Global Markets Research Team.