USD: Observations on the 100 Level

Quietly, the US Dollar Index has moved above the 100 level. The 100 threshold has been the peak of the dollar's three rebounds over the past year and is also a very important technical level. Therefore, let's discuss the market observations around this critical 100 mark.

First of all, what is the main driving force behind this round of dollar rebound? Spreads, spreads, and more spreads. Since May, the US vs. non-US interest rate spread has clearly widened, which highly corresponds to the US dollar's rebound. Currently, the 2Y US vs. non-US spread maps to a dollar index center around 101. From the perspective of spreads, the fundamentals for this round of dollar rebound are more solid than previous ones.

Why has the US vs. non-US interest rate spread widened? At its core, it's due to diverging monetary policy expectations among the G7 countries. As mentioned in the previous article “Mid-Year FX Market Outlook: Shadows Under the Scorching Sun”, the tightening cycles of different countries have diverged—some countries can continue to hike rates, while others can't. Data shows that in the past month, the rate hike expectations for the UK, Australia, and Canada have declined, while those for the Eurozone and Japan remain stable, and the US is one of the few economies where hike expectations continue to climb.

Besides the US vs. non-US interest rate spread, another important logic behind this round of dollar rebound is risk aversion. As we're at mid-year, many investors mention this: K-shaped divergence. Moreover, this year's K-shape is not quite typical—the upper arm is getting thinner and the lower arm is getting thicker. This “non-standard K-shape” suggests sustained market demand for safe-haven assets, regardless of whether the AI sector is crowded.

Within safe-haven assets, gold has been limited this year due to structural issues in the flow of funds, and its safe-haven properties are not strong (see “Gold: Market Observations at 4,300”). Looking back at the first half of the year, the US dollar has been the best safe-haven asset.

For safe-haven currencies like the US dollar, “whether positions are crowded” is also an important issue. From my observation, current dollar positions are not yet considered crowded. The 25D risk reversal implied volatility of the dollar against a basket of currencies is around its historical 60%-70% percentile, suggesting there is room for further development and momentum.

So, is the dollar index at the 100 level a starting point or an endpoint? In my view, 100 is not the endpoint—the real action in the second half of the year is just about to begin.

To summarize today's sharing:

1. The US Dollar Index has reached above the key 100 level, which is also an important technical threshold. What is the main driving force of this round of US dollar rebound? Spreads, spreads, and more spreads. The widening of the US vs. non-US spread essentially stems from diverging monetary policy expectations in G7 countries;

2. Besides the US vs. non-US interest rate spread, another key driver of this dollar rebound is risk aversion. Globally, the K-shaped divergence is becoming more pronounced, with a thinner upper arm and a thicker lower one. This “non-standard K-shape” means there will remain continuous demand for safe-haven assets in the market, and the US dollar is the best safe-haven this year;

3. In terms of position structure, the current dollar positioning is slightly net long, but not yet at crowded long levels—there's still room for further development and amplification. I tend to believe that 100 is not the end for the US Dollar Index, and the main show for the second half of the year is just about to begin.