MUFG reports that the USD has been consolidating at weaker levels against other major currencies over the past month. This has seen the dollar index trade within a narrow range, with most G10 currencies within +/-1% of where they were trading against the USD in the middle of the previous month. This price action suggests that the FX market is currently struggling for direction after the USD sell-off recently lost downward momentum.

This resilience of the USD partly reflects that the US rate market has already moved significantly to price in a policy reversal from the Fed. Nearly 75bps of cuts are already priced in by the end of the year, with the first cut expected by September.

It would require more convincing economic data in the coming months to reinforce expectations for even deeper rate cuts. Recent developments, however, are dampening optimism over the outlook for growth outside of the US, providing more support for the USD.

The USD sell-off since late last year has been partly driven by the improving cyclical outlook for growth in China and Europe. However, doubts have started to creep in recently over the strength of growth.

The approaching US debt ceiling standoff has the potential to create choppy price action in the coming weeks/month, which could temporarily disrupt MUFG's outlook for further USD weakness. The most likely outcome is a compromise agreement to extend the debt ceiling for a short period that is conditional on plans for future spending cuts.

Once the dust has settled over the US debt ceiling, MUFG expects the USD to resume its decline, but anticipates more volatile FX markets as the "x-date" approaches.