US Dollar: Stretched positioning caps gains against peers – BNY

BNY’s Geoff Yu notes the US Dollar (USD) enters the Federal Open Market Committee (FOMC) with strong recent demand but stretched positioning, as cross-border buying and late-July spot demand remain supportive. However, month-end rebalancing, light hedge ratios and softer cash demand raise the bar for further gains. Yu argues only a clearly hawkish Fed surprise is likely to restart broad USD buying.

Stretched positioning into FOMC decision

"The dollar enters the FOMC with strong recent demand but increasingly stretched positioning. Cross-border buying and late-July spot demand remain supportive, but month-end rebalancing, light hedge ratios, and softer cash demand raise the bar for another leg higher. A clearly hawkish Fed surprise is now needed to restart broad USD purchases."

"Cross-border flows continue to anchor overall USD demand, and their lead in average flow scores remains clear. Dollar hedge removal and fresh longs were strongest in June, when the gap between cross-border and local demand was also widest. Even so, interest is softening into month end."

"For foreign investors, the lack of hedging on U.S. assets is beginning to look excessive. Month-end rebalancing should generate more hedge demand, although weaker equities and fixed income may already be reducing exposures and mechanically lifting hedge ratios. The adjustment may therefore come through both active hedging and passive exposure reduction."

"Recent dollar flows have seen the strongest buying phases on record, but they end the month under heavy rebalancing pressure, especially through equities. Price action is already struggling ahead of the Fed, and dollar purchases are fading even as markets price some risk of a hike. The EUR offers a useful warning: even a notably hawkish central bank may not support its currency when positioning is stretched."

"The bar for the Fed to restart broad USD buying is therefore very high. The recent buying phase has already absorbed much of the available positive policy signal."