Bank of America Forex Insights

Bank of America Forex strategists recently remarked that the overvaluation of the U.S. dollar is “no longer a headwind” for investors. A recent depreciation has brought the dollar index (DXY) closer to its fair value, marking its first approach to this level since March 2024.

According to BofA, although the dollar is no longer overvalued, it also isn’t “cheap” enough to inspire a strong move against it. This indicates a more balanced risk outlook in the near term.

Analysts remain bearish on the USD over the medium term; however, the recent sell-off exceeded their expectations for 2024. This overshoot is, in part, due to a positive outlook for USD/JPY and a stabilization of macroeconomic risks in the U.S.

Caution is advised against adding USD shorts at this juncture since market positioning has become more balanced, with immediate risks appearing more evenly distributed. BofA mentions that while some speculative positions, particularly in short-term carry trades, have been unwound, residual interest among exporters and institutional investors may still bolster support for the dollar.

Analysts predict ongoing structural outflows from corporates and households unrelated to short-term rate differentials could weaken JPY.

Moreover, China’s economic conditions continue to significantly impact the outlook for the dollar according to BofA. Despite some decoupling between the DXY and China-related market sentiment, the analysts emphasize that the economic recovery in China—or lack thereof—remains crucial.

Should China have displayed stronger growth signals, particularly regarding the property market and credit expansion, the greenback might’ve faced more downward pressure. However, with the property sector contracting and sluggish credit growth, the potential for a critical negative impact on the dollar is limited.