The re-pricing of the Federal Reserve cycle is the second key channel. 1m USD OIS rates priced one-year forward have quickly bounced 25bp since the start of the conflict. That not only makes dollar hedging costs more expensive, but a bearish flattening of the US yield curve is normally a dollar positive by what it means for growth prospects.
This leads us to the third channel of a stagflationary shock hitting a market positioned overweight Europe and emerging markets in anticipation of synchronised world growth. An unwind of these inflows, which had been building since last summer, is also buoying the dollar.
Back in 2022, we noticed that the shift in terms of trade (export versus import prices) was a key driver in raising the fundamental medium term value of the dollar. That is why making a call on the duration of this energy shock is so important. Our baseline of more settled energy markets by the end of the month should mean the dollar starts to hand back some of its recent gains. Meanwhile, a three-month plus shock would be another, more bullish dollar matter entirely.
