The “ unexplained residual” captures the remaining net movement in the USD since mid-October that is not captured by these macro environments. The DXY has risen more than 10% since mid-October 2021 and the net cumulative gain in the DXY that cannot be explained by our “macro buckets” is a large 4.6ppts. This component can be thought of as the USD’s momentum driven gains. While the Fed’s hawkish pivot has of course been instrumental to the USD’s gains, our methodology surprisingly suggests that only about +2ppts of DXY gains since mid-October occurred when markets traded in a fashion consistent with hawkish Fed pricing. We assume “hawkish” Fed price action plays out when equities fall and both the USD and US 2yr yields rise. But when we measure the USD’s net movement when these conditions prevailed the DXY’s net gain since mid-Oct was comparatively mild, at +2ppts. A hawkish Fed has been undeniably crucial, its just that its role has potentially played out for the DXY with a lag – and thus not captured by our methodology. Shifting risk appetite (black bars) has been a key driver recently too. When we isolate those periods when the DXY fell and US yields and US equities rose (and vice versa) we find the DXY overall shed a net 2ppts from mid-Oct to mid-Feb 2022, meaning risk appetite was a net drag on the DXY. But since then, the DXY’s net movement when markets trade as though risk appetite was the key driver has been +2ppts. The Ukraine Russian war and angst over China’s recovery have been key market drivers recently, and our estimation approach suggests these developments have accounted for about +2ppts of DXY upside since mid-February. Our best read is each of these factors have scope to sustain further near term DXY upside; leading US activity indicators are edging lower, but the US offers a much more compelling growth story than Europe’s acute stagflationary picture and China’s Covid constrained growth story. The Fed is unlikely to shift tack until inflation is contained and risk appetite overall looks set to remain unsettled for sometime to come. - Westpac Strategy
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