BofA expects additional USD weakness following the August sell-off, citing historical patterns, valuation concerns, and shifting global financial conditions.
Key Points:
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Historical Patterns:
- DXY Downtrend: After similar bearish breakouts in the past, the DXY index has typically continued its decline, averaging an additional 4% drop. This trend suggests further USD weakness, particularly against EUR, GBP, and AUD, though less so against SEK, NOK, and CHF.
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Valuation Concerns:
- Overvalued USD: Despite August’s drop, broad nominal and real USD trade-weighted indices remain at Q4 2022 levels, indicating the USD may still be overvalued. The recent USD sell-off has been mainly against European currencies, leading to a divergence between DXY and other USD indices.
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Global Financial Conditions:
- Falling Yields: US 10-year Treasury yields typically decline following the Fed’s first rate cut. This trend, combined with loosening global financial conditions, could contribute to further USD weakness. Other central banks, having cut rates earlier, may now benefit from the Fed’s actions, indirectly supporting their economies and putting additional pressure on the USD.
Conclusion:
BofA anticipates more USD downside based on historical patterns, current valuation metrics, and the impact of global financial conditions. The USD’s recent sell-off and ongoing divergence from other indices bolster the case for continued weakness.
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