Dollar Rally Faces Resistance From Pull of Global Real Rates

Authored by Simon White, Bloomberg macro strategist,

Higher real rates worldwide are challenging haven demand for the dollar.

Almost three weeks into the Iran war, the dollar has done as it’s expected to do in risk-off episodes: rally.

Comparing to other US-led conflicts, its rise has been faster than average, but has faded somewhat in the last few days.

The chart shows the median move in the DXY before and after US-led military operations going back to 1980, from the attempted hostage rescue from the US Embassy in Tehran that year, to the “12 Day War” when the US and Israel attacked Iranian nuclear facilities last June, for 11 episodes in total.

As discussed recently, the risk-off playbook has likely changed, and it can’t be assumed the dollar will rally as much as it has in previous risk-off instances, whether militarily linked or not.

That’s a more structural argument based on capital flows to the US and stress to the dollar-based global trading order. But it’s supported cyclically too.

The chart below shows that the global real policy rate is rising faster than that for the US.

The market has been reluctant to mark up expected rate-rises in the US due to the Federal Reserve’s dual mandate and the prospect of a new chair who might not turn out to be much of an inflation fighter.

Rates in the rest of the world, such as Europe and the UK, are now pricing in hikes, from cuts before the war started.

Altogether this is a headwind for the dollar.