The market's persistent worries about risks in the artificial intelligence sector continue to weigh on the appeal of the U.S. dollar, and with AI-related market fears still unresolved, the dollar's overall position has become more fragile.
Yesterday, the dollar briefly weakened following initial news of progress in the Middle East situation. That price action also prompted investors to reassess the potential impact of geopolitical easing expectations on dollar-denominated assets.
Now, if oil prices fall further, the risk of a hit to the dollar is increasing. Dollar trading continues to carry a softer tone. Intraday buying interest is weak, and the willingness of bulls to actively push the dollar higher has clearly cooled.
In our view, this stems partly from the lingering effects of AI-related concerns, and partly from the ongoing unwinding of previously overly bullish dollar positions and short-term valuation bubbles. However, based on short-term valuation indicators, the dollar is no longer significantly overvalued.
Among G10 currencies, the pound, the Norwegian krone and the Australian dollar are slightly overvalued against the dollar; the Canadian dollar and the Swiss franc are roughly in a fair-value range; and the euro, the yen, the Swedish krona and the New Zealand dollar remain undervalued. It is worth noting that all of these currencies are within a 1.5 standard deviation range, so the degree of valuation divergence is limited and no strong valuation signal has emerged.
Yesterday's market also once again confirmed that lower oil prices are bearish for the dollar. Unconfirmed reports said progress had been made in Middle East talks, Brent crude briefly fell, and this pushed the dollar index down to 101.50 at one point.
As crude supply conditions improve, high oil prices now increasingly rely on geopolitical risk for support. Once regional tensions cool, the crude premium will fade quickly. Therefore, if a signal of genuine easing appears, the foreign exchange market may begin to price in a sharp drop in crude prices.
Over the past week or so, the logic behind the dollar's reaction to oil price moves may already have changed. Rising concerns about tech stocks have somewhat weakened market confidence in the Federal Reserve maintaining a hawkish stance. Investors have begun to lower their expectations for how long high rates will last, and in the face of non-data drivers such as a sharp oil price slump, short-term rates now have greater room to turn dovish.
We acknowledge that the broader environment of a weakening dollar has already tilted the risk balance further toward the bearish side for the dollar. Even so, we still judge that the dollar will decline gradually and in an orderly way, rather than suffer a sharp depreciation. Fundamentals have not produced any major bearish factor strong enough to trigger a dollar collapse, and the overall backdrop of Fed policy, oil prices and interest rates still provides support for the dollar.
There is no important U.S. economic data due for release today. Yesterday's unexpected drop in housing starts further confirmed that the real estate market is deteriorating. As an important pillar of the U.S. economy, continued weakness in housing will give the Fed new policy considerations.
The market's focus today will be on whether any new progress emerges from U.S.-Iran negotiations.
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