💲 Westpac: USD Vulnerable via Interest Rate Differentials For Many Months Yet

• We estimate lower US rates have already contributed to about 2ppts of the DXY’s near 4% decline.

• DXY’s hourly movements into macro buckets - US growth sentiment, risk appetite, Fed expectations and an unexplained residual.

• Our rationale is that the directional trend in the USD, rates and US equities as a group betrays the dominant market narrative. For example, when the DXY, US rates and US equities all rise or fall together it’s a sure sign US growth sentiment is the main market driver. Fed expectations capture the DXY’s net movement when the DXY, US equities and US rates move in a way that is consistent with a shifting Fed expectations. For example, dovish Fed price action is associated with a lower USD, lower rates and higher equities, and vice versa for a more hawkish shift. Lastly, “risk appetite” price action shows the DXY’s movement when risk seems to be the dominant driver; for example, when we see a lower USD, higher US rates and higher US equities (for risk on conditions) or a higher USD, lower US rates and lower US equities (for risk off conditions).

• Each of these macro themes have had their day in the sun. But in recent weeks, the bulk of the USD’s decline has been associated with shifting Fed expectations (purple bar below), i.e. when US rates are also falling and when US equities. Cooler US growth sentiment has also played a key role in recent weeks too.