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A relief rally is due, but timing it is tricky.
The dollar has rallied by over 2.0% against its main counterparts since last Wednesday's FOMC decision, a win that's lasted six straight days but now looks primed to snap.
The dollar index - a measure of broad dollar strength - is on the charge, slicing through the 100-100.50 resistance zone to touch 101.80 midweek.
"The US Dollar has finally done what it spent most of the past year threatening to do: break out of its range. DXY has cleared the 100.50 ceiling and is trading at a one-year high, helped by a flatter US curve, a fresh drop in EUR/USD through 1.14, renewed pressure on USD/JPY above 161, and a broader risk-off mood," says Kevin Ford, a market commentator at Convera.
The pound has withered in the face of the dollar's advance: the pound-to-dollar conversion has retreated to the support layer at 1.3160. But this is also an important support zone for 2026 trade, and it's the first technical hint that it's time for the dollar bull run to tone it down.
The second indicator is the overbought state of the dollar index, where the daily RSI powered to 74.67 (lower panel in chart below) when the ndex peaked Wednesday. That's highly unusual for the dollar which tends to quickly retreat from such an overbought state.
Still Too Soon To Bet on a Reversal
Make no mistake, the speculative community is itching to jump on the dollar and sell it from current levels.
Stategist Brent Donnelly at Spectra Markets thinks a short-USD trade is a plum bet, but he's cautious about breaking cover too soon.
"I am waiting for the right tactical moment to get short dollars, but we are not quite there yet as corporate month end approaches and gold continues to plummet," he says.
Caution is certainly warranted as jumping too soon could prove costly.
"GBPUSD having a sniff at 1.30 here below which there is a lot of clear space. Similar for EURUSD and 1.13. FX has been so boring recently ... maybe no longer?" says Claus Vistesen, macroeconomist at Pantheon Macroeconomics.
Month-end, PCE Inflation Complications
One reason to be cautious about betting against the dollar just yet is the likely skew in month-end flows towards the dollar, and another set of strong economic prints from the U.S.
It was announced Thursday that U.S. core PCE inflation came in at 0.3%, in line with expectations but still hotter than the previous 0.2%. "Putting volatile oil prices to one side, this reinforces the view that underlying inflation is still running too hot for comfort, with sticky wage inflation in the service economy a major driver," says Lindsay James, investment strategist at Quilter.
Final GDP for Q1 surprised strongly at 2.1% versus 1.6% expected.
Given that the primary driver of the dollar rally has been June's above-consensus U.S. activity data, these firm data will underpin the dollar into the turn of the month.
Month-end flows are also likely to complicate matters, explains Spectra's Donnelly:
"Corporates need dollars and will keep needing dollars for a few more days. My view is that this is creating a USD-positive feedback loop where specs are adding and techs are breaking."
The Tide Will Turn
Although there's a case to be made for further USD upside in the coming hours and days, the case for a USD setback is increasingly compelling, and it's just a matter of when, not if.
The dollar trade is crowded to the upside, positioning data showes a net-long position that's reached its highest level in 16 months. And of relevance to the GBP/USD in particular, the pound is also crowded, but to the downside.
"Speculators are heavily short sterling, close to levels seen shortly after the Brexit vote ten years ago," says Georgette Boele, Senior FX Strategist at ABN AMRO. "The market is net long the US dollar and slightly long the euro, according to the latest data. This matters."
Crowded positioning can be a significant headwind for a trend and can often precede a turn, although a compelling trigger is typically required.
A potential early trigger could be an undershoot in Thursday's PCE inflation release.
Fed Pricing Overdone
May and June saw a rapid repricing in expectations for what the Fed will do to interest rates when they make their next adjustment, from favouring a cut to favouring a hike.
The odds of a rate rise grew rapidly last week when the first Fed meeting under Chairman Kevin Warsh was unexpectedly open to such a move.
Not only did it bolster the dollar via the interest rate channel (U.S. bond yields jumped), but by committing to targeting inflation, Warsh calmed fears that the Fed's credibility would be sacrificed in the pursuit of economic growth.
The restoration of credibility won't be lost anytime soon and should underpin the dollar. But a mismatch in interest rate expectations offers potential for volatility.
"Markets are now pricing in around 38bp of rate hikes until the end of 2026, which has been an important driver of dollar strength," says Boele. "We think markets may have moved too far. We do not expect rate hikes and continue to expect that the Fed will start easing around the turn of the year."
ABN AMRO says dollar strength can continue into the short-term, but once the prospect of a reversal will build after the Northern Hemisphere summer and focus turns to the November mid-term elections in the U.S.
It's the scale of any repricing in Fed expectations that will determine whether a short-term counter-trend move against the dollar's trend evolves into a more enduring reversal.
Dollar Strength Here to Stay: JPM
JP Morgan isn't buying the view that the dollar's about to roll over. Instead, they see a steady grind higher for the currency into year-end.
In a mid-year strategy update, the Wall Street bank says a new FX regime is in place:
"We transformed from 'bullish beta, bearish USD' to 'bullish beta, bullish USD' in March," reads a new analysis note detailing why we're in a phase of renewed dollar outperformance.
Put simply, the American exceptionalism trade, where stocks and the dollar rise, is back.
In H2 "global growth recovers but USD exceptionalism lingers," and "U.S. cyclical strength and yield dominance will underpin the dollar"
JP Morgan thinks a hike is coming and forecasts about 3% of broad USD upside, which it says is consistent with previous hiking episodes.
History shows the dollar tends to reliably appreciate by approximately 5% in the period between ~6 months leading up to the first Fed hike to ~1 month after.