BNY's Geoff Yu asserts that the US Dollar remains undervalued in real effective terms, even after recent gains against the Japanese Yen (USD/JPY), Euro (EUR/USD), and Canadian Dollar (USD/CAD) [1]. Yu points out that while Eurozone growth and inflation have softened, U.S. price dynamics are strengthening, which supports the case for further appreciation in the Dollar’s Real Effective Exchange Rate (REER) [1]. He emphasizes that, by historical standards, the dollar is not at the extremes seen during previous periods of U.S. economic outperformance [1].
Yu highlights that the resilient JOLTS report reinforces expectations that upcoming U.S. labor market data will continue to support higher U.S. yields and a stronger dollar [1]. He believes that concerns about dollar overvaluation are premature and that the divergence between the U.S. and other economies gives the dollar’s REER more room to appreciate [1].
However, Yu warns of risks associated with demand-driven inflation, particularly wage growth, which could prompt a more aggressive response from the Federal Reserve and negatively impact broader risk sentiment [1]. He also notes that a materially stronger USD REER could tighten global financial conditions by compelling central banks to address imported inflation and increasing the cost of dollar funding, which is already scarce [1].
CONCLUSION
BNY's analysis suggests further upside for the US Dollar's real effective exchange rate, driven by U.S. economic strength and global divergence. However, risks remain from potential demand-driven inflation and tighter global financial conditions if the dollar strengthens further. Market participants should monitor U.S. labor data and inflation trends for future direction.