BNY’s Geoff Yu notes that strong U.S. equity performance and broad Dollar buying have left global asset allocators heavily exposed to the Dollar into month-end. He argues that some reduction or hedging of USD positions is needed, even as the macro fundamentals behind recent flows are likely to persist and Fed expectations remain key for Dollar exposures.

Dollar exposure seen as overstretched

"Risk sentiment is set to end May on a strong note, but gains are mostly concentrated around AI and semiconductor themes. The U.S. has been a standout performer, and the dollar ended the month as the best-bought currency by far among the tracked majors. Consequently, it’s no surprise that the notion of “U.S. exceptionalism” has resurfaced."

"Nonetheless, based on equities alone, asset allocators are ending the month heavily exposed to the greenback, and some reduction or hedging is needed. The only other equity-based rebalancing signal is in the CAD, where growth and asset allocation trends are pointing in the opposite direction."

"The fundamentals that drove the flow and broader asset market price action, however, are likely to continue. Specific U.S. equity sectors will likely continue to run independently of broader macro developments, and dollar exposures in the meantime may continue to rise if Fed expectations move further away from a dovish or neutral position."

"The tipping point will be when Fed tightening or broader tightening in U.S. financial conditions is no longer conducive to equity performance, but the market appears to view that as a tail risk at best."

"In contrast to equities, fixed income-based rebalancing has generated more signals due to significant steepening across key G10 markets as inflation expectations surged throughout the month. USD and CAD have again generated the same net selling and buying signals, though the dollar’s signal is far weaker, as poor bond performance offset dollar purchases."

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