US Dollar: AI-linked flows weigh on outlook – MUFG

MUFG’s Lee Hardman notes the Dollar index has retreated from a year-to-date high near 102.95 and slipped back below its 200-week moving average around 102.10. He highlights that stronger US inflation failed to trigger further Fed repricing, while massive foreign inflows into US equities and credit tied to AI optimism leave the Dollar more vulnerable if sentiment reverses.

US Dollar tied to AI sentiment

"The major foreign exchange rates have remained stable overnight with the US dollar continuing to trade at modestly weaker levels following last week’s correction lower. The dollar index closed lower last week brining an end to four consecutive week of gains that had lifted it to a fresh year-to-date high of 102.95. It has since fallen back below resistance from the 200-week moving average which comes in at around 102.10."

"The US dollar’s failure to extend its gains last week following the release of stronger US inflation data was disappointing and has likely encouraged some investors to trim long positions accumulated over the past month. Despite the stronger US inflation data, which further highlights the limited progress towards the Fed’s inflation objective, market participants have been reluctant to price in a more hawkish policy path. Market pricing for a back-to-back Fed rate hike later this month has fallen to only around 3bps after Fed Chair Kevin Warsh at the end of last week refrained from signalling a clear need for another increase so soon after last month’s initial hike."

"US financial markets have been a major beneficiary of strong foreign investor demand driven by AI-related optimism. Foreign investors purchased USD942 billion of US equities in the twelve months to July, while purchases of US corporate bonds increased sharply to USD452 billion over the same period. These sizeable inflows highlight how the USD has become increasingly tied to investors’ search for higher returns in US financial markets, rather than benefiting from its traditional safe-haven status."

"At the same time, the US dollar’s pullback this week has coincided with a wobble in AI-related trades. After reaching a fresh record high earlier this month, Bloomberg’s AI equity index has since fallen by around 9%. The correction has been even more pronounced in semiconductor and neocloud equity indices."

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