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In our FX review this week, we take a look at the move higher in the US Dollar Index (DXY), why AUD spiked and what to watch out for on the data front.

The DXY marches on

After treading water since the Fed meeting last month, we finally got an answer as to the next direction in the DXY. The index pushed higher, particularly towards the end of the week.

This was highlighted with key breaks in some pairs vs USD. For example, GBPUSD broke below 1.3000 on Friday, the lowest level in two years. EURUSD broke below 1.09 and importantly closed in the 1.08’s, opening up more downside for next week. USDJPY finished the week back above 124, in a move that showed the retracement lower could have already finished.

The main reason for this jump in USD comes as the short end of the US yield curve continues to rally. When we refer to the short end, we are talking about maturities up to two years out. Within this timeframe, the market continues to increase expectations of rate hikes from the Fed this year.

If we fast forward to the end of this year and US rates are at 2%, it’s clear why we are seeing USD appreciate. The UK are in a much more conservative position than a few months ago, with maybe a couple more hikes due this year. In the Eurozone, even with high inflation it’s unlikely that we will see the deposit rate return to positive territory in 2022.

So as an investor looking for yield, it makes sense to be heading to the USD. Even as we see concerns around Ukraine start to dissipate, the tightening of monetary policy is likely to keep the dollar strong for some time in our opinion.

Aussie enjoys some time in the sun

Another notable outperformer this week was AUD. This stemmed from the Reserve Bank of Australia’s meeting overnight on Monday. It appears that the bank are going to join the party in hiking rates later this summer. Even though they kept current rates on hold at 0.1%, the change in language was enough to get investors excited.

AUDUSD pushed easily above 0.7600 early in the week, a jump of 1.3%. Even though this retraced due to the USD bid to close the week, we continue to like being long AUD.

What to watch next week

Next week there is a lot of high level data out that could cause volatility. From both the UK and US, we have inflation, employment and GDP readings. Of note will be US CPI inflation on Wednesday, where consensus is for a 8.3% gain, versus 7.9% previously. The Eurozone figure is also due on Tuesday which will be worth watching out for.

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