During May, the US dollar weakened notably against the euro, moving from 1.2029 to 1.2195. The US Dollar Index also drop by 1.6%. The increased evidence of US yields being in equilibrium will help keep the US dollar under downward pressure over the near-term, according to economists at MUFG Bank. 

Key factors ahead will determine policy expectations and the dollar

“Crucial for the markets will be events going forward that will determine the Fed’s reaction function. But to arrive at a point of ‘substantial progress’ toward its goals, some notable gains in employment will be required. Secondly, a period of time is required in order to assess the sustainability of inflation expectations (10yr breakeven) which have reached around desired levels. Our assumption is that inflation will indeed prove transitory and while some big increases in jobs are likely, it will be some time before recovery is in sight.”

“The USD will be influenced by the outlook for fiscal policy. The GOP has rejected the White House toned down $1.7trn infrastructure spending program making it likely President Biden will have to go it alone. We expect infrastructure and social spending plans to get approved although the overall size may be smaller.”

“Our lower US yield profile means we have brought forward our USD depreciation more into Q3 and Q4. However, 2022 brings risks of the short-end of the US yield curve starting to turn higher in anticipation of rate hikes in 2023. That could see the USD show some degree of modest recovery by the end of Q1 2022.”

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