USD: Risk is of a sharp reversal of dollar strength similar to that experienced in 2008 – Deutsche Bank

In a special report from Deutsche Bank, analysts consider the dollar will remain somewhat overvalued thanks to strong global demand in uncertain times, but could eventually reverse quickly as global dollar funding pressures ease.

Key Quotes: 

“The foreign exchange market has been dominated by widespread dollar hoarding in recent weeks that led to an appreciation of the dollar. Recent central bank actions, most notably the expansion of FX swap lines to more central banks as well as the Fed’s corporate credit facilities, have helped alleviate some of the immediate stress and many liquidity indicators have normalized. Once immediate dollar demand abates, we think the risk is of a sharp reversal of dollar strength similar to that experienced in 2008.”

“The dollar has significantly overshot fair value, interest rate differentials between the US and the rest of the world have collapsed and it is now very cheap for foreign corporates and investors to hedge their underlying dollar exposure. What is more, we worry that the rest of the world will be able to manage the healthcare and economic fallout from the virus crisis better than the US.”

“Most notably, the medium-term impact of the crisis on the unemployment rate is likely to be larger in the US and Europe given the differentiated emphasis on labor protection schemes, while Europe in aggregate is likely to be able to manage an exit strategy from the containment phase of the crisis more sustainably than the US. All of this points to building dollar weakness over the remainder of the year.”