USD set to strengthen as market’s conflict optimism looks overdone – MUFG

Risks of renewed deterioration in the Ukraine conflict appear very high. Therefore, US dollar strength since the invasion of Ukraine could be about to change given the limited scope for any near-term improvement, economists at MUFG Bank report. 

US curve could reach conversion point more quickly than expected, lifting USD

“We fear the hope of peace may now be a little excessively priced which could see European currencies turn weaker versus USD once again. If China was to indicate more explicitly its support for Russia as the US have indicated, a wider contagion in market pricing could well unfold. All of this coupled with a hawkish Fed communication point to renewed USD appreciation.”

“If market conditions worsen once again, which seems more likely than not to us, the US 2s10s curve is likely to flatten further toward the point of inversion. The correlation with the US dollar is not perfect but periods of flattening from 50bps down to 0bps have coincided with US dollar strength – Mar ’97 to Jan 2000 (+11%); Apr 2005 to Dec 2005 (+8%); Apr 2018 to Aug 2019 (+8%). So the history for the US dollar is pretty good at this juncture for the 2s10s curve spread. We wouldn’t expect the same extent of gains due to the current level but US dollar strength looks likely.”