The USD is at a Crossroads

 The USD is currently influenced by two conflicting forces, each driving its path in different directions. On the positive side, the anticipation of a second presidential term for Donald Trump could lead to increased fiscal stimulus and new tariffs on US imports. This, in turn, could elevate US inflation, thereby boosting rates and yields. Conversely, on the negative side, market expectations for Federal Reserve (Fed) rate cuts have been growing due to recent weaker-than-expected US inflation and economic activity data. Presently, the latter force appears to dominate, reflecting its immediate impact with the first Fed rate cut anticipated in the upcoming months.

USA CPI 

 Source: Finlogix Economic CalendarThe anticipation of Fed rate cuts is becoming more prominent, with the first cut expected soon. This has led to a defensive stance on the USD in the near term. However, many of these Fed-related negatives are already factored into the USD's price, as indicated by the high probability (approximately 80%) that investors attach to three rate cuts this year. This outlook appears overly pessimistic, and upcoming US economic data and Fed communications could challenge this perspective.

FEDWatch

 Source: CME FedWatchIn the FX market, many negative factors are already priced into the USD, as evidenced by the reduction in USD long positions by investors. This indicates that only a significant deviation from expected data would have a lasting impact on the currency. The current sentiment suggests that the USD might be more resilient to negative data than previously thought, given the already adjusted market positions.

In summary, the USD is at a crossroads, influenced by both potential fiscal policies and imminent Fed rate cuts. While the expectation of rate cuts currently prevails, the market may have already priced in much of the negative outlook. Therefore, upcoming economic data and Fed communications will be crucial in determining the USD's future trajectory.

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