DXY: Overvalued USD consolidates - Scotiabank

After a solid start to the year yesterday, broad dollar gains have been checked back somewhat, leaving the Dollar Index (DXY) in consolidation mode into the weekend, Scotiabank's Chief FX Strategist Shaun Osborne notes.

Strong USD advance leaves valuation looking stretched

"Some restraint in the dollar's overall advance would not be too surprising, despite its robust performance in the past couple of weeks. Fundamentals are favourable and seasonal trends suggest that strength is likely to persist through Q1. But the gains in the DXY are looking stretched relative to our fair value estimate based on rate differentials alone."

"There is a Trump premium being built into the USD on the assumption that the presidentelect's policies will be pro-growth, perhaps somewhat inflationary and therefore supportive of the USD."

"But the DXY is trading close to two standard deviations above its spread-based equilibrium estimate now and sustaining that sort of performance may prove difficult without drivers warranting such a performance. Moreover, gains are prone to a reversal if market assumptions about Trump policies are challenged--in terms of scale, scope or timing, for example."