USD overvaluation no longer a headwind: BofA

Bank of America Forex strategists said that the overvaluation of the U.S. dollar is “no longer a headwind” for investors, following a recent depreciation that has brought the dollar index (DXY) closer to its fair value. This marks the first time since March 2024 that the DXY has approached this level.

According to BofA, while the dollar is no longer overvalued, it also isn't "cheap" enough to warrant a strong move against it, suggesting a more balanced risk outlook in the near term.

Analysts remain bearish on the USD over the medium term, but the recent sell-off has surpassed their expectations for 2024. This overshoot is partly attributed to a positive outlook for USD/JPY and the stabilization of macroeconomic risks in the U.S.

They caution that adding USD shorts at this stage may not be prudent, as market positioning has become more balanced and the immediate risks appear more evenly distributed.

BofA notes that while some speculative positions, particularly in short-term carry trades, have been unwound, there is still residual interest, particularly among exporters and institutional investors, that could sustain support for the dollar.

“We still expect structural outflows from corporates and households that are not premised on short-term rate differentials to eventually weaken JPY,” analysts said.

Meanwhile, China's economic situation continues to play a crucial role in shaping the outlook for the dollar, BofA emphasized.

Despite some decoupling between the DXY and China-related market sentiment, analysts argue that China's economic recovery—or the lack thereof—remains a key factor.

They suggest that if China had shown stronger growth signals, particularly in the property market and credit expansion, the greenback might have faced even greater downward pressure. However, with China's property sector still contracting and credit growth remaining sluggish, the potential for a significant negative impact on the dollar remains limited.

Source: Investing.com