US Dollar: Undervaluation flags downside risks – MUFG

The US dollar appears undervalued according to MUFG’s G10 regression models, potentially exposing investors to risks stemming from the Middle East conflict, inflation concerns, and potential political influence at the Federal Reserve. US-backed intervention in the Yen, along with a subtle push for broader Dollar devaluation against Asian currencies, might prompt investors to sell the Dollar during periods of market uncertainty.

Eight of the nine G10 currencies show the US dollar as undervalued, suggesting this underperformance may have been priced into the FX market already. A potential Middle East ceasefire deal may have contributed to this perception, as reflected in the models. Another factor could be intervention by the US Treasury, which took a more significant role due to its support for Japan in attempting to strengthen the Yen and weaken the US dollar – even though the Treasury did not directly sell the Dollar.

The negative implications of an undervalued Yen may drag down valuations for Asia FX in general, including the renminbi. The recent communications between President Trump and Fed Chair Warsh, as well as the perception of greater political influence undermining Fed independence, might also be factors in the Dollar’s underperformance.

Additionally, concerns over financial market developments in Washington could erode confidence in holding US assets, potentially leading to more US dollar hedging in the future. GBP/USD ended the week slightly defensive, trading near the low 1.3600s, following gains earlier in the day. EUR/USD, meanwhile, declined modestly around 1.1670 after failing to advance past 1.1700.

The US Dollar’s recent weakness may be contributing to gold's recent advance, temporarily surpassing $4,600 per troy ounce, despite the Dollar's rise and another day of rising US Treasury yields. Cryptocurrencies, including Bitcoin, Ethereum, and Ripple, also show a bullish trend. The US Treasury announced a significant increase in liquidity support buyback operations for 10-year to 30-year sectors, lifting the maximum from $2 billion per operation to at least $4 billion, effective September 9 and running until November 4.