Dollar dominance: Why FX conviction is so low? - HSBC

Research Team at HSBC notes that the FX correlations have gone up since the US presidential election which is very different to other asset classes as USD-based pairs are moving as a block, with very few exceptions.

Key Quotes

“The aftermath of the US Presidential election has seen currency markets move through two distinct phases. In the first phase we saw a strong appreciation of the USD against most other currencies. This phase lasted until the end of 2016. From the beginning of 2017 until today we have been in the second phase. This phase has seen a dramatic reversal of direction with the USD weakening against almost all other currencies.”

“These USD moves have been dramatic. More importantly, they have happened in sync against most currencies. As a result, correlations between USD-based exchange rates have become much stronger since the election.”

“This is very different to what we find for other asset classes. We found that the election had led to a sharp fragmentation between different assets.” 

“For these other asset classes, this fragmentation raises the possibility that diversification is back. In contrast, most USD-based pairs have become variations on the same theme. Unless you have a strong view on what will happen to the USD, this makes it very hard to trade FX at the moment.” 

“We believe that this explains why conviction in the FX market is currently so low. However, once the market has moved past the near term USD risks then it is likely that currencies will begin to respond to other factors again.”