US Dollar: Real strength and REER outlook – BNY

BNY’s Geoff Yu argues that the US Dollar remains undervalued in real effective terms despite recent gains in USD/JPY, EUR/USD and USD/CAD. He notes that Eurozone growth and inflation have softened while U.S. price dynamics strengthen, supporting further appreciation in the Dollar’s REER. Yu highlights risks from demand-driven inflation and warns that a stronger real Dollar could tighten global financial conditions.

Dollar valuations and real effective gains

"The resilient JOLTS report reinforces our view that this week’s labor market data should continue to support higher U.S. yields and a stronger dollar. After the recent moves in USDJPY, EURUSD and USDCAD, valuation concerns are bound to resurface. We think those concerns are premature."

"By historical standards, the dollar is nowhere near the extremes seen during previous episodes of U.S. exceptionalism."

"As this divergence widens, the dollar’s REER has further room to appreciate."

"We continue to expect further gains in the dollar’s REER. The main risk is a sharp acceleration in demand-driven inflation – particularly wages – which would force a more aggressive Fed response and weigh on broader risk sentiment."

"On the other, a materially stronger USD REER tightens global financial conditions by forcing central banks to respond to imported inflation while raising the cost of already-scarce dollar funding."