MUFG’s Lee Hardman notes the US Dollar index (DXY) is trading just below year-to-date highs, with the US Dollar posting a second straight week of gains after the Fed’s hawkish update. He highlights widening expectations for monetary policy divergence versus Europe, outlines scenarios for EUR/USD between 1.1400–1.1800 or below 1.1000, and maintains a long USD/NOK recommendation.

Fed divergence underpins Dollar strength

"In our latest FX Weekly report on Friday we highlighted how widening expectations for monetary policy divergence between the Fed and other major central banks particularly in Europe have triggered a bullish break out for the US dollar."

"We see two main scenarios for EUR/USD over the remainder of the year. In our base case, where the Fed does not follow through with rate hikes, we expect EUR/USD to move back up into the 1.1400–1.1800 range that has prevailed over the past year. Alternatively, if the Fed delivers multiple rate hikes, EUR/USD could fall further below 1.1000."

"Evidence of slowing US inflation and/or a less hawkish Fed reaction function would support a weaker USD, and vice versa in the months ahead."

"For now, we maintain our long USD/NOK trade recommendation until the recent hawkish repricing of Fed rate expectations is convincingly challenged."

"Looking ahead, this week’s ECB annual policy forum in Sintra should provide further insight into the extent to which monetary policy paths in Europe and the US are likely to diverge."

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