MUFG’s strategists note that the US Dollar (USD) has weakened despite solid United States (US) jobs data, as optimism over a potential US/Iran deal and surging US equities support risk appetite. They highlight downside risks to the US economy, scope for Federal Reserve (Fed) easing later this year, and warn that prolonged conflict and energy shocks could eventually limit Dollar selling.

Dollar pressured by risk appetite

"The US dollar weakened further last week with no resolution to the Middle East conflict in sight. Attacks in the Strait of Hormuz increased but the US maintains the ceasefire remains in place. That has seen oil prices drop over the last week."

"The magnitude of such strong risk appetite is lifting global optimism and encouraging US dollar selling. A strong US jobs report was not enough to trigger US dollar strength. The US Dollar could still see renewed gains and the longer the Strait of Hormuz remains closed the greater the potential of a turn in risk sentiment."

"We would still conclude that downside risks to the economy remain more relevant at this stage of the cycle. The Michigan Consumer Sentiment index fell to a new record low on Friday with the cost of living concerns very likely the source of the latest downturn in confidence. This is coinciding with softening nominal wage growth that is set to translate into continued weak growth in real incomes."

"Weak real income growth will likely encourage the Fed to ease its monetary stance later in the year, assuming there is no escalation in the conflict that results in larger inflation increases. That backdrop for US consumers, the prospects of continued geopolitical uncertainties and the risk of renewed trade uncertainties with Trump threatening further tariff actions do not suggest a sustained pick-up in labour demand is imminent."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)