Nordea:
...the Fed and many other central banks still seem intent to try to look through the recent “inflation” rise, which has for instance translated to the lowest 2y real rates ever (when derived from breakevens). This probably helps explain some of the recent price-action in the dollar.
a dive into historical returns of the dollar index DXY on data since 1974, given different levels of the US real rate. This time we define it as the 3m T-bill rate less the 12mma of core PCE inflation. We get the following chart. Peculiarly, if we get to truly depressing(!) real rates – which seem likely given the core PCE figures out in the coming week, the DXY could actually gain. At least that would be the conclusion from the observations from the first half of the 1970s.
Generally, we find that there is a huge discrepancy between how to trade reflation and how to trade inflation. The reflationary environment (potentially including a doom-loop) is almost always USD negative, as has also been the case over the past year. When expectations are being build up, growth perspectives are being repriced in a positive direction, which is good news for the commodity-linked FX space such as AUD, NOK and EM.
When ACTUAL core inflation starts printing at higher levels, then there is usually only one true winner left in the FX market and that is the USD. If we see sticky US core inflation during H2 (we bet so), then you know where to place your bet. Long USD vs. EM (and potentially also scandis). One could argue that we are already very close to entering this phase. We keep long USD/SEK alive for this reason (S/L at 8.19), but opt to close our short EUR/GBP position (entered Feb 22nd) with a small profit as the EU is now catching up to the UK in the vaccination process.
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