USD bullish case has lost sparkle – SocGen

Research Team at Societe Generale, sees significant counter-forces and that is precisely why they suspect a fall in FX volatility over H2.

Key Quotes

Valuation. The fresh Peterson Institute’s FEER (fundamental exchange rate estimates) sees the USD as 7% overvalued. We expect the IMF’s (annual) external sector report this summer to deliver a similar conclusion. With the Fed so cautious and real USD rates stuck at depressed levels, the upside is limited, barring a major accident in China or Europe.

The risk is that the US economy continues to disappoint into the election (political uncertainty is a drag), in which case the Fed will find it hard to raise rates. Global financial conditions depend on the Fed, and that too could tie its hands.

More importantly still, the panic capital outflows in China early this year have made it clear that global policy makers want to avoid extreme USD strength. The G20 meeting in Shanghai made that patently clear in February. Broad dollar strength tends to force USD/CNY higher as China wants to avoid a rise in the RMB index. USD/CNY gains tend to fan capital outflows, threatening to disrupt global financial conditions.”