Dollar Rally May Slow as Central Banks Hike Rates Globally

The US dollar's recent rally may be facing headwinds as other central banks, including the European Central Bank (ECB), start their own cycles of monetary tightening. According to JP Morgan, the greenback was undervalued by approximately 2-4% before the Federal Open Market Committee (FOMC) meeting, based on various factors, including interest rate differentials.

The narrowing yield spread between 30-year and short-term US bonds has indirectly signaled market confidence that the Fed will effectively combat inflation by raising interest rates. Historically, a narrowing spread has supported the greenback. However, this time it's more a result of buying longer-term bonds as short-term yields rise with rate hikes.

The return to the yen as the funding currency for carry trades is helping the euro find its footing. The risk of intervention to break the upward trend in USDJPY had previously forced traders to steer clear of the Japanese currency, using the euro to fund their trades instead.