Synopsis: Credit Agricole highlights an intriguing divergence between the recent rally in US rates and yields and the simultaneous underperformance of the USD. Despite US 2-year rates reaching their highest since 2006 and 10-year yields nearing their 2007 peak, the USD hasn't mirrored this strength. Several factors contribute to this phenomenon, including rising rates outside the US and substantial profit-taking from extended USD long positions.
Key Insights:
Disconnect Between Rates and USD: US rates and yields have witnessed a significant rally, with 2-year rates hitting a pinnacle since 2006 and 10-year yields approaching their highest since 2007. Yet, the USD hasn’t rallied in response, indicating a disconnect.
Global Rate Dynamics: Rates and yields are also climbing in other countries (e.g., Australia), potentially diluting the USD's appeal in real terms, despite its gains against certain currencies.
Positioning and Profit-Taking: The USD, currently the most substantial FX market long, appears to be experiencing profit-taking, contributing to its underperformance. This trend suggests a strategic pullback from overextended long positions.
USD’s Relative Undervaluation: Short-term fair value models indicate the USD is undervalued against the EUR, GBP, CAD, and JPY. These models consider various fundamental FX drivers, including relative rate differentials.
Conclusion: Credit Agricole identifies a noteworthy decoupling between rising US rates and the USD's unexpected underperformance. The analysis suggests that this trend may continue in the short term, driven by global rate increases and profit-taking in the FX market. However, the growing undervaluation of the USD, particularly against major currencies, presents a compelling case for its potential rebound, especially if the current market dynamics persist.
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