Beware of the risk of a dollar reversal

With the U.S. June CPI data rebounding for the first time in three months, market concerns about the gradual impact of tariffs are emerging, leading to a delay in interest rate cut expectations, which correspondingly caused a rebound in the U.S. dollar index and dollar interest rates. Although since the second quarter, the market has consistently been bearish on the dollar index and has been buying non-dollar currencies on dips, every rise in the dollar index has been viewed as a rebound rather than a reversal. However, compared to the early stages of de-dollarization trading in April and May, the current momentum of the euro and yen indicates that the sentiment of selling dollars on highs is loosening. I believe that this time we need to be wary of the risk of a dollar reversal for the following three main reasons:

First, the sustainability of the "de-dollarization" trading theme

Since the second quarter, the biggest trading theme in the market has been "de-dollarization"—Trump's reciprocal tariffs and erratic subsequent policies, along with frequent interference in the independence of the Federal Reserve, have impacted the credibility of the dollar, leading overseas funds to collectively flee dollar assets.

However, from a time cycle perspective, the de-dollarization theme has been ongoing for over three months, and the market, which has become aesthetically fatigued, is in dire need of new topics. So, if CPI remains high, could tariff-induced inflation be the next topic?

Furthermore, from the perspective of the de-dollarization theme itself, it was previously widely believed that overseas funds increasing their dollar exposure for hedging was one of the reasons for the dollar's decline. However, according to recent research by Deutsche Bank, investors who are hedging have raised their hedging ratios to a considerable level, while other investors, constrained by execution, are adjusting their hedges slowly, making their foreign exchange hedging a slow and long-term process.

Table: Deutsche Bank's survey on client hedging situations

Second, technical aspects and position holdings

From a technical chart perspective, EURUSD has broken below the upward trend line since March on the daily level, with a MACD death cross indicating potential adjustment demand.

Chart: EURUSD daily level breakout

This is corroborated by Citigroup's recent weekly fund position data, which shows that euro shorts are accumulating. It is also worth noting that leveraged money is going long on the dollar.

Chart: Citigroup's observation of recent weekly flow situation

Looking back at the dollar index, it has currently broken through the 20-day moving average, with the next target corresponding to the 50-day moving average around 98.8. Since February of this year, the dollar index has consistently operated below the 50-day moving average, and once it completes an upward breakout, it will signal a dollar reversal Of course, achieving this will be inseparable from the corresponding decline of the euro, the largest component currency of the US Dollar Index.

Chart: The 50-day moving average of the US Dollar Index is around 98.8

Third, interest rate differentials and interest rate cut expectations

Before the end of the month, there will be a vacuum period for important US data, making it easier for the market to continue the perspective that "tariffs will affect inflation." Therefore, the possibility of a rate cut in September must be questioned (unless the story of Powell stepping down continues to develop). Against the backdrop of relatively resilient hard data in the US and a rebound in CPI, the fundamental advantages and interest rate differential advantages will further support the US dollar—currently, the correlation between EURUSD movements and interest rate differentials is starting to revert, which means that if US dollar rates trend upwards, EURUSD will also be under pressure.

Chart: The probability of a rate cut by the Federal Reserve in September is only 50%

Chart: The correlation between EURUSD movements and interest rate differentials is reverting

In summary, whether analyzing the sustainability of the "de-dollarization" main line or from the perspectives of technical analysis, positions, and interest rate differentials, the US dollar has established preliminary conditions for a reversal. So, will the first event to trigger this be the Japanese Senate election this weekend?

Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investing based on this is at one's own risk