US Dollar: Hedging impulse fades as holdings stabilize – BNY

BNY’s Geoff Yu points out that the July FOMC-driven Dollar hedging impulse has largely dissipated, with early signs of USD buying returning against the EUR, MXN, and CAD. Trade-weighted Dollar holdings are historically light, indicating potential for stabilization. However, sustained recovery hinges on robust U.S. asset demand and renewed real-rate leadership.

Our flows exhibit the first indications of dollar stabilization following a challenging August. After occupying a significant portion of Q2 and Q3 as part of the "U.S. exceptionalism" trade, the dovish interpretation of the July FOMC meeting triggered a surge in dollar hedging. While a single day doesn't constitute a trend, the past three weeks suggest there was no inclination to aggressively add to dollar hedges.

The Fed's indication of continued rate hikes removes the principal catalyst for dollar sales in early August. Overall, USD holdings remain elevated, yet without a reversal of the policy gap between the U.S. and its peers, no further constraints on dollar performance are anticipated, barring tariffs-related factors. Even sans tariffs, enhanced performance vis-à-vis the currencies of primary U.S. trading partners would represent supplementary tightening through pass-through effects.

We anticipate dollar holdings to stabilize around existing levels as Fed expectations have evolved. Idiosyncratic market considerations may deter aggressive additions to MXN, CAD, and EUR, while the influence of CNY is waning. Transitioning the dollar towards a scenario of holdings recovery necessitates strong asset interest and leadership in real rates.

Qualitatively, this demands the Fed to adopt a restrictive policy stance, a trajectory that virtually eliminates asset performance, particularly in equities. (This article benefited from the assistance of an Artificial Intelligence tool and subsequent editorial review.) The FXStreet Insights Team comprises journalists who meticulously select market observations from distinguished experts.

The material encompasses insights from commercial analysts along with additional perspectives from internal and external analysts. USD/JPY extends its sell-off below 157.00 in European trading on Thursday, as traders react adversely to the weak US ADP report, driving down the US Dollar across the board and reinstating the downward pressure on the pair.

Simultaneously, hawkish BoJ expectations and the possibility of intervention continue to bolster the Japanese Yen, rendering it detrimental to the major. AUD/USD struggles to capitalize on the previous day's rebound from a near two-week low and fluctuates above 0.7150 in Asia on Thursday, as dismal Australian trade data dampen the optimism despite upbeat China's RatingDog Services PMI.

However, the pair's upside remains constrained as the US Dollar stalls the weak ADP report-led decline amid escalating US-Iran tensions and firming September Fed rate-hike expectations. Gold sustains its bid pressure heading into the European session, yet remains below $4,450 amid mixed fundamental cues. Sliding US bond yields and Wednesday's subdued US ADP report support the US Dollar, aiding the commodity in recovering from a near four-week low.

However, surging US Federal Reserve rate-hike expectations and rising inflation risks due to higher energy prices could serve as a tailwind for US bond yields. Ripple and Stellar exhibit contrasting technical outlooks as market participants gauge whether the recent weakness could evolve into a recovery. XRP identifies support and establishes a pivotal support zone, whereas XLM slips below a cluster of Exponential Moving Averages.

The oil market may seem calmer than it did a few months ago, but diesel presents a stark contrast. The US diesel crack spread, the premium of ultra-low sulphur diesel futures over West Texas Intermediate, recently surpassed $100 per barrel for the first time, reaching an intraday record of just over $102.00.