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Crédit Agricole's bullish USD stance has been vindicated, but "we conclude that there could be only limited further upside for the USD."
The call is made in the bank's latest weekly FX publication that lands at the end of a second consecutive upweek for the dollar index, taking the past fortnight's cumulative advance to 1.5%.
"The hawkish outcome of the June Fed policy meeting has been the most important recent event for FX markets, helping propel the USD to its highest level in more than a year of late," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.
There seem to be two FX drivers at play, he explains:
(1) the pricing in of Fed rate hikes due to market concerns about sticky inflation and also despite the absence of any Fed guidance to that effect; and
(2) the unwinding of USD-debasement hedges that have been put in place since the start of President Donald Trump’s second term on the back to growing fears about fiscal dominance over the Fed.
Above: Dollar index reaches overbought, according to RSI in lower panel.
The Warsh Reaction is Set to Fade
The dollar's strength validates Crédit Agricole's long-standing bullish outlook for the currency; however, the run higher could be reaching its limits.
"We think that the current market Fed rate hike expectations are already looking too aggressive and worry that the USD could suffer if the FOMC disappoints the hawkish bets," says Marinov.
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 proved unexpectedly open to raising rates in order to establish dominance over inflationary forces.
Regarding the credibility premium unwind, Crédit Agricole's calculations - based on measures of rates and gold - suggest the U.S. debasement theme has "eased considerably already."
Analysts at the bank conclude that many Fed-related positives are already in the USD price by now.
On Thursday, we reported that a recovery in the GBP/USD pair was looming as the USD was looking increasingly primed to reverse direction following an impressive winning streak over the past ten days.
The findings from Crédit Agricole provide some additional evidence that, at the least, the big USD move is set to fade.