In “Hard Landings, Bond Vigilantes And Angry Villagers,” I mentioned the somewhat daunting conjuncture of a stronger dollar, higher oil and higher Treasury yields.

Eventually, dollar strength could brake crude’s ascent, but the dynamic looked a bit self-fulfilling recently: Higher crude pointed to upside inflation risk, which in turn increased hawkish risks around the Fed, biasing the dollar stronger and so on. Breakevens are up ~10bps from late last month.

At the same time, the dollar appeared to respond to August’s fireworks at the long-end of the Treasury curve, where supply concerns commingled with term premium repricing and the r-star debate to drive yields higher. Long-end US reals at 2% are the highest in living memory for younger market participants.

The greenback is now riding an eight-week stretch of gains into the CPI update in the US.

Depending on which gauge you prefer, that’s the best streak of weekly gains in a very long time.

As the simple chart shows, we’re still well off levels on the DXY seen this time last year, when the market was coping with a vengeful Fed perturbed by a summer equity rally which Jerome Powell snuffed out with a terse address at Jackson Hole.

Fast forward to 2023, and the Fed was more tolerant of summer stock strength, Powell wasn’t irritable in Wyoming and if the Fed isn’t done hiking, they’re almost done. Ostensibly, that argues for a softer dollar. But with the European economy teetering, the outlook for China murky and Japanese monetary policy still trapped in Neverland, strategists aren’t so sure.

“Even with some data cooling, there is still a material gap between the health of the US economy and that of its principal counterparts (EU, China),” JPMorgan strategists including Meera Chandan wrote. “This suggests the US exceptionalism underpinning the dollar’s latest bout of resilience is still intact.”

The bank observed that in August, the trade-weighted dollar was more tightly correlated to long-end US yields than policy-sensitive short-end rates. The two figures underscore the point.

“Such moves are unusual, and co-movement with FX tends to be either short-end-led or across all sectors in broad-based curve shifts,” Chandan continued, adding that the dollar has also “regained some sensitivity to outright yield levels.”

Still, rate differentials are the key in FX. “The policy debate taking shape for the round of meetings later this month helps underscore why the dollar remains resilient,” Goldman’s Kamakshya Trivedi remarked, highlighting the figure below.

“Even though Fed officials seem to agree on another pause while the ECB is still actively debating a hike, FX responds more to the forward outlook, so it matters that Fed officials are still debating whether policy is ‘sufficiently’ restrictive, while even the ‘hawks’ on the ECB seem to be pitching this as a chance to sneak one more hike before the data turn even more decisively against them,” Trivedi said, in the same note.

Ultimately, JPMorgan seems to expect FX moves will revert to a more familiar state of affairs wherein currencies move based on short-end rates and policy expectations, but Chandan cautioned that “longer-end repricing remains a wildcard for G10, particularly given the technical nature of the move over the last month.”

I realize the above doesn’t make for the most compelling reading, but it’s an important background dynamic to consider ahead of US CPI and the ECB meeting this week. The dollar is overbought from a technical perspective, and a ninth week of gains would be quite remarkable. Generally speaking, risk assets have a difficult time coping with unabated dollar strength.

“There are three main themes driving exchange rates now: US economic outperformance, China’s dramatic economic slowdown and the Treasury market’s reaction to bond supply (and growth),” SocGen’s Kit Juckes wrote. “We think the bond market is super-important and for the first time in a while, it’s being driven by supply/demand dynamics — large and frequent auctions at a time when some of the big foreign buyers of Treasurys (China most notably) might be buying less in the future,” he went on, before asking if there are “echoes of Reagan/Volcker in Biden/Powell.”

The title of Juckes’s latest monthly was “The dollar loves bond vigilantes.” “Does easy fiscal policy make the Fed’s fight against inflation all the harder?” he wondered. “The whole idea of FX ‘fair value’ was temporarily thrown in the bin in 1984/1985 and I’m not inclined to say significant further dollar gains are impossible.”