Crowded Long Positions on the US Dollar

2. Oil prices fall, and rate hike expectations are hard to support the dollar

The core driver of the latest dollar rally comes from the market’s advance pricing of the Fed’s hawkish policies,with the dollar index’s movement highly related to the expected rate hikes from the Fed over the next year.

Currently, the market is pricing in 1.3 Fed rate hikes this year, with a 75% probability of a hike before September, slightly down from post-June FOMC highs. However, the decline in US dollar interest rates still lags the significant drop in oil prices.The fall in oil prices will gradually ease inflation,reducing the necessity for continued Fed hikes,and the rate support for the dollar continues to weaken.

3. Seasonal weakening window for economic data

In June and July, US nonfarm payrolls data often show seasonal weakness: on one hand, school summer vacations result in temporary departures from public education positions, and many women exit the labor market to look after children; on the other, July is traditionally a time for automakers and other manufacturers to halt operations for maintenance, leading to temporary layoffs. Therefore, summer employment data naturally experience seasonally downward disturbances, and high-frequency indicators such as JOLTS and ISM manufacturing also face possible weakening.

4. AI positives fully priced in, marginal benefits fading

The boost to US productivity from AI is a core bullish logic for the dollar in the mid-to-long term, but in the short-term, this positive has already been priced into the dollar’s strength.BofA’s June investor survey shows that 80% of institutions believe that going long on global semiconductors is the most crowded trade. When volatility in tech stocks increases, it may weaken foreign capital’s motivation to continue assets into the USD.

5. Geopolitical risk premium supporting the dollar continues to decline

With the US and Iran reaching a ceasefire memorandum of understanding, the Middle East situation has cooled down significantly, Hormuz Strait shipping traffic has recovered to about 30% of normal levels, and overall Middle East strait traffic has risen to around 60% of norm. The previously supportive geopolitical risk premium for the dollar is rapidly declining.

Summary:

Currently,US dollar long positions are rather crowded. Coupled with falling oil prices, seasonal weakening of summer economic data, AI benefits being fully priced in, and fading geopolitical risk premium, a confluence of factors is increasing the pressure for a short-term correction at the dollar’s highs.