HSBC delves into the current dynamics of the USD and its potential to establish a trend, especially as the influence of yield differentials diminishes across the G10 FX.

Key Points:

• Waning Influence of Yield Differentials: As policy rates across most of the G10 FX approach or touch their peak, the influence of yield differentials on currency movements is lessening. However, they aren't entirely irrelevant, especially for certain high-yielding Emerging Market currencies.

• Return of Risk Appetite: The diminishing role of rates in driving FX means that risk appetite (Risk On/Risk Off or RORO) is re-emerging as a key driver. This presents a dynamic where both rates and RORO do not always move in the same direction for the USD. In 2022, these forces were both in favor of a stronger USD, but now the scenario has changed, making it more challenging for the USD to establish a clear trend.

• HSBC's Stance on the USD: HSBC maintains a bearish outlook on the USD. This view is grounded in the belief that the most likely scenario for the US and the global economy is a soft landing. However, a few factors need alignment before this view solidifies:

  • Evidence that US core inflation can decelerate without necessitating a sharp downturn in the US economy.
  • Economies outside the US should demonstrate resilience and not underperform, ensuring that the anticipated soft landing is a global phenomenon and not just limited to the US.

Conclusion:

HSBC is exploring the potential for the USD to trend again amidst shifting dynamics in the FX market. They argue that for a clear direction to be established, there needs to be evidence of manageable inflation in the US and steady economic performance globally. Until these factors align, the trend of the USD remains uncertain.