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While FX
markets
have calmed down somewhat, the Federal Reserve is still on an
aggressive rate hike path that could see rates in the U.S. rising above 3% next
year. Furthermore, geopolitical tensions remain high, and the conflict between
Russia and Ukraine could drag on for a prolonged period of time.

From a
technical perspective, the U.S. Dollar does appear overbought. Let´s have a
look at the Dollar Index (DXY) and its performance since the beginning of the
year. The index is up almost 8% year-to-date. The RSI on the weekly chart is
signalling overbought conditions, suggesting that the Dollar has already surged
to lofty heights.

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That being
said, the recent economic data is supporting faster monetary policy tightening
by the Fed, and there are no immediate signs that their hawkishness might be
fading in the near-term. While markets are already pricing in rates rising to
2.75% – 3% until year-end, investors are concerned that the central bank will
be forced to accelerate tightening.

The
Greenback is also benefiting from strong demand for safe havens as markets
remain in risk-off mode. Geopolitical tensions have spiked to their highest
level in a while. Unfortunately, the war in Ukraine may not end that soon, and
there are fears that it could spill across borders. The impact of Russia´s
invasion of Ukraine is already far-reaching, and an overall rise in
geopolitical tensions could put the global economy at risk – just as it was
recovering from the scars of the pandemic.

What could
cause the Dollar rally to stall? Once markets see the Fed´s hawkishness waning,
we could see a larger correction in the US Dollar. Since the market is already
pricing in an aggressive hiking campaign, it would not take too much to trigger
a dovish repricing.

A recovery
in risk appetite might cause additional headwinds. Equity markets managed to
regain some ground recently, although there might be further turbulence ahead.
All eyes are on the technology sector where one-time darlings got crushed.

Against which currencies could the U.S.
Dollar have better chances of outperforming?

The Euro has
been in a strong downtrend since June 2021. The weakness of the common currency
has initially been driven by a dovish and passive ECB. A spike in inflation,
the war in Ukraine and bleak growth prospects have created additional pressure.
The European Commission recently slashed its economic growth forecast for the
euro zone by 1.3 points to only 2.7%.

Meanwhile,
inflation is expected to remain closer to 7%. While the ECB has turned somewhat
hawkish – it may hike rates as early as July this year – it might end up being
a case of too little, too late. It could therefore be only a matter of time
until EUR/USD hits parity – the next major bear target.

The
short-term outlook for the British Pound remains mixed at best. The dovish
repricing after the most recent Bank of England meeting triggered a significant
sell-off. Pound traders have shifted their focus from inflation to the central
bank´s dramatic warnings about a significant economic slowdown. GBP/USD has
been recovering quite slowly from this. While a breakout above 1.25 might
trigger a short squeeze, there is an elevated risk of a bull trap being around
the corner.

How will the commodity currencies
perform?

The
Australian Dollar has been suffering from a broad risk-off theme and China´s
COVID crisis, which sparked concerns about a slowdown of the economic
powerhouse. An improvement in risk appetite could give the Aussie Dollar a
boost, but weak economic data out of China could continue to cause notable
headwinds in the near-term.

The Canadian
Dollar could have it easier in the short-term. The surge in oil prices have
kept the currency supported, and there is scope for the Bank of Canada hiking
rates more aggressively over the coming months.

Stay ahead
of the markets and trade your edge with Axi.

Disclaimer: The
information is not to be construed as a recommendation; or an offer to buy or
sell; or the solicitation of an offer to buy or sell any security, financial
product, or instrument; or to participate in any trading strategy. Readers
should seek their own advice. Reproduction or redistribution of this
information is not permitted.



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