A Break Above 96.50 may set the Stage for new leg of USD Rally
The increased geopolitical premium and rotation out risk assets on expectations of higher Fed rate have made a significant contribution to the weakening of currencies tied to business cycle fluctuations or those that correlate with equity returns. High uncertainty around the situation in Ukraine may discourage investors to buy those currencies in near-term, at the same time, the strengthening of the yuan is a signal that Asian currencies will be in demand.
If at the very beginning of the year the search for yield by US investors abroad weakened the dollar, then towards the end of January the situation changed - accelerated correction in equity markets and increased geopolitical instability, reversed these capital flows and the factor of a safe haven asset again came to the fore in USD valuation. The combination of these factors has made the less popular choice of currencies correlated with the business cycle - AUD, CAD, NOK. In particular, due to the JPY's highest negative correlation with risk assets, a 12% correction in the S&P 500 has driven the AUDJPY, a popular risk-off hedge, down 4% year-to-date.
The sharp rebound of the S&P 500 on Monday, from a low of 4223 to 4409 at the close, suggests that the “buy the dip” spirit in the market has not gone away. Expectations for the pace of Fed rate hikes have also ebbed, from four to three hikes this year. Surveys also show that the share of cash in investors' portfolios is relatively high and there is a potential that they will offer support to the market during declines.
However, the yield search in the European expanses has somewhat decreased due to the uncertainty around Ukraine and possible consequences for the energy market so the factor of the dollar weakening at the beginning of the year - the search for yield of US investors in Europe, may now be added in the dollar equation with a positive sign. The current dollar rally is likely to hit the main resistance at 96.50, a break higher after the Fed may mean the beginning of the next stage of the strengthening of the US currency:
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