The USD Breakout That Won’t Break
The USD has moved sideways this year, but its behavior has become more defensive since the Iran war began. After fears of a USD “exodus” last year, the dollar has instead acted as a safe-haven during the Iran war. The DXY’s correlation with implied volatility has also increased since the start of the conflict; correlations with both the VIX and MOVE indexes remain near multi-year highs.
The DXY is breaking out of its recent range, but that breakout will be limited as the main bullish drivers have already been priced in. On the technical side, speculative long positioning has increased, but is not stretched. Investor sentiment also remains positive, but is not stretched either. Sentiment can be a useful contrarian indicator when it reaches extremes, but it is not the case now.
We therefore expect the DXY to consolidate tactically. A bullish catalyst to consider is further hawkish Fed surprises, but leading inflation indicators have been cooling alongside commodity prices. As we recently highlighted, the Fed’s front-loaded hawkishness is paradoxically acting as a dampener on rates volatility for now. Another possible bullish driver for the dollar would be further equity stress, materializing in a VIX spike. For now, however, the current equity shakeout looks more like a rotation out of recent AI winners than a broad selloff. We therefore remain tactically cautious on the DXY and see consolidation ahead barring a larger decline in equities.