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Feb 28 - 09:55 AM

BofA: Analyzing the Recent USD Overshoot and its Implications

By eFXdata  —  Feb 28 - 09:23 AM

Synopsis:

Bank of America (BofA) offers insights into the recent dynamics surrounding the US Dollar (USD), particularly in relation to the DXY dollar index and its divergence from traditional drivers. Observations highlight the complex interplay between Fed repricing, equity markets, China sentiment, and carry trades, advising caution against buying USD at current levels, especially against the Japanese Yen (JPY), due to potential policy resistance.

Key Insights:

  • Fed Repricing and USD Strength: The USD has been supported by a repricing of Federal Reserve policy expectations, although this has been somewhat counterbalanced by strong equity performance and improving sentiment towards China.

  • Divergence from Key Drivers: Notably, the DXY dollar index has shown a meaningful divergence from its key drivers in contrast to January, suggesting an overshoot in USD valuation.

  • Caution against USD Purchases: BofA urges caution against purchasing USD at its current levels, particularly versus the JPY, due to the risk of intervention or policy resistance from Japanese authorities.

  • Impact of Technology Stocks and China Sentiment: The analysis reveals that the relative performance of technology stocks has a lesser impact on G10 FX, while a strong negative correlation exists between US rates and China sentiment. This correlation underscores the People's Bank of China's (PBoC) reaction function and suggests that eventual Fed easing could significantly influence USD dynamics.

Conclusion:

BofA's observations on the USD's recent overshoot reflect the complexity of currency market dynamics, highlighting the need for a nuanced understanding of the interplay between various economic indicators and policy decisions. Investors are advised to exercise caution in the current environment, particularly in transactions involving USD/JPY, as the market assesses the broader implications of Fed policy adjustments, equity market performance, and shifts in sentiment towards China.

Source:
BofA Global Research

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