Source: the finishing touch of Zhongjin

The sharp weakening of the dollar since the end of last year is essentially due to directional inflection points in both Chinese growth and US inflation. While it is itself the result of improved risk appetite, the rapid weakening of the dollar has boosted the performance of many assets, such as gold and other commodities, emerging market exchange rates and capital flows. Obviously, the weak dollar has become the consensus of the market and is the premise and basis of many transactions at present.

Chart: the recent significant appreciation of the RMB is mainly affected by the warming of China's growth expectations, but more deterministic expectations in the direction since November have been included.

Source: Bloomberg, China International Capital Corporation Research Department

In the short term, growth in China and improved inflation in the US are expected to continue to support this direction, which is the main reason why we think the positive window is still in place in the first quarter. However, in terms of overcrowding and risk-return ratio, the more valuable thinking for investors is that if the dollar reverses in the short term, what might happen, such as whether the unexpected inaction at this week's interest rate meeting of the Bank of Japan will be an opportunity? Where can there be a difference in expectations? What will be the impact?

First, where is your current position? The trading level is oversold and the bulls are decreasing, the technical level is close to the support level, and it deviates significantly from the global liquidity indicators.

From a multi-dimensional point of view, the current position of the dollar is expected to be a preemptive run and a trading "overdraft". Specifically,

1) expectations outpace expectations of falling inflation in the United States and improved growth in China. The inflection points of US inflation and Chinese growth in November suppressed the dollar index in both positive and negative directions. However, considering that the current US debt interest rate has been included in the expectation that the end point of interest rate increase is less than 5% and there will be two interest rate cuts at the end of the year, we believe that there is an obvious "snatch", not to mention that compared with the US debt that has been revised back before, the US dollar has basically not revised.

2) the trading is approaching the oversold range, and the long position is decreasing. The RSI point of the dollar index has fallen further and is close to the oversold range. At the same time, long dollar positions also fell significantly, with contracts down 63.3% from their June 2022 highs.

Chart: affected by the market expectations of the central bank of Japan to adjust its YCC policy last week, the US dollar RSI point has fallen further, approaching the oversold range.

Source: Bloomberg, China International Capital Corporation Research Department

Chart: us dollar long positions also fell significantly.

Source: Bloomberg, China International Capital Corporation Research Department

3) the technical level is close to the support level, and the monthly level of the dollar index is close to the support level of 100.

4) it deviates obviously from the global index of "cheap money" that we have constructed. We measure the impact of monetary policy on liquidity by calculating the balance sheet changes of the four major central banks in Britain, the United States, Japan and Europe. At the same time, by calculating the credit pulses of the private sector in major countries (China, Australia, Europe, Japan, Switzerland, Britain and the United States, etc.) as the effect of credit derivation outside the monetary authorities, we add the two together to get the "cheap money" index of global liquidity.Historical experience shows that this indicator is highly related to the trend of the US dollar. In fact, the recent downward trend of the US dollar has also been captured by our model, but the extent of the decline is significantly higher than the level estimated by the model, indicating that there is too much overdraft.

Chart: we calculate the changes in the balance sheet size of the four major central banks and the private sector credit pulses in the major countries with a high share of global financial markets.

Source: Bloomberg,Haver, China International Capital Corporation Research Department

Chart: historically, this indicator fits well with the trend of the US dollar compared with the same period last year.

Source: Bloomberg,Haver, China International Capital Corporation Research Department

Looking back, based on our model calculations, the global "cheap money" indicator may point to the dollar in the short term, and a larger downward inflection point may occur in the second half of the year. The downside risks we measure come from stronger-than-expected policy support in China and a more-than-expected decline in US inflation, while the upside risk is that persistently high US inflation has led to longer Fed tightening and increased global recession pressure.

Chart: according to the historical law, this indicator shows that there is still room for the dollar to rise, and there may be a clear downward inflection point in the second half of the year.

Source: Bloomberg,Haver, China International Capital Corporation Research Department

Second, if it is reversed, what may be the reason? Interest rate hikes stop expectations are fully taken into account, growth pressure and recession expectations are expected to rise

In fact, the apparent overselling and expected rush on the deal itself provide the possibility of a short-term phased reversal. So where can there be a difference in expectations?

First, the full inclusion of expectations of the end of interest rate hikes and expectations of excessive easing may be corrected. Recent dollar weakness is based on expectations that the Fed's tightening will stop or even ease. The direction of the decline in US inflation has become consistent, but the greater uncertainty is the speed and end of the decline in the second half of the year (depending on service-oriented prices). The expected end point of interest rate hike is already lower than the Fed's bitmap guidelines (4.75 vs. 5.1%), and the market expects two interest rate cuts at the end of the year, which may be difficult to push forward in the short term. After the interest rate increase at the FOMC meeting in early February further slows down the 25bp and is expected to stop raising interest rates in March, there may be a policy gap without expectations of interest rate cuts for a period of time.

Chart: the inflection point of current US inflation has been established and the Fed's rate hike is coming to an end; we expect overall and core inflation in the US to fall to 3% and 4% by the end of the second quarter.

Source: Bloomberg,Haver,CME, China International Capital Corporation Research Department

Chart: the end point of interest rate hike expected by the current market is already lower than the Fed lattice chart (4.75% vs. 5.1%)

Source: federal Reserve, China International Capital Corporation Research Department

Second, growth pressures and rising recession expectations could lead to risk aversion. We expect recessionary pressure to increase in the US in the second quarter. Historically, in the US recession cycle, the US dollar tends to remain strong because of factors such as risk aversion and capital return. The direction of China's economic growth repair has been counted continuously since November, but the final degree of repair depends on the level of consumer repair and real estate recovery, the speed of which is difficult to prove in the short term. If the Chinese economy is less than expected in terms of policy support and consumption repair after the two sessions, or if unexpected geo-risks occur again, it may lead to a stronger sense of risk aversion.

Chart: we expect the recessionary pressure in the United States to gradually magnify by the end of the second quarter, thus increasing the pressure on the molecular side of US stocks.

Source: Bloomberg, China International Capital Corporation Research Department

Chart: from historical experience, the dollar often strengthens in historical recession cycles

Source: Haver, China International Capital Corporation Research Department

Third, short-term catalyst? Central Bank of Japan YCC stands still to eliminate short-term downward pressure

At the end of last year, the central bank unexpectedly adjusted its YCC target, giving more downside reasons for the already sharply weakened dollar, while the concern that the BoJ might further raise or even completely cancel the YCC also made it difficult for the market to trade around easily ("the asset impact of the BoJ's unexpected adjustment of the YCC ceiling"). However, on Wednesday, the central bank unexpectedly decided to leave the existing interest rate and YCC control ceiling unchanged (0.5%).[1]As a result, the market's previous adjustment expectations have failed, so the short-term elimination of short-term downward pressure on the dollar may become an event catalyst for short-term trend changes.

Chart: the Bank of Japan publishes monetary policy decisions, unexpectedly leaving existing interest rates and YCC control caps unchanged

Source: Bloomberg, China International Capital Corporation Research Department

Looking forward, it is still reasonable and possible to further raise or cancel YCC, but the time may be in mid-March or even after April. After the adjustment at the end of last year, Japanese bonds are still basically operating at the upper limit under the decline in US bond interest rates, and the Bank of Japan still has to continue to buy Japanese bonds at a greater cost (the amount of daily bond purchases by the Bank of Japan has set a record one after another, reaching 4.6 trillion and 5 trillion yen on January 12 and 13, respectively.[2]), and looking forward to the help of external Fed interest rate cut expectations is also "distant water cannot quench the near thirst". Therefore, greater bond-buying pressure and higher domestic inflation in Japan may still make it possible to eventually adjust or even cancel YCC. The CICC Foreign Exchange Group expects the possibility of another unexpected adjustment at the interest rate meeting in mid-March, while there are market voices that may have to wait until the next president arrives after President Kuroda's term expires in April.

Fourth, what if the impact of reversal? Short-term may lead to profit-taking or reversal of some transactions, especially when it is expected to include too many assets

Gold's larger excess earnings may come as recession fears heat up in the second quarter. The recent rebound in gold, in addition to interest rate cuts expected to push interest rates down, but also affected by the decline of the dollar, has also been significantly overbought, the current increase does not rule out the rush. The next opportunity for overallocation and outperformance comes from market volatility and forced interest rate cuts after the second quarter due to rising recession pressures, which could fail or even fall before and after, based on the experience from the end of interest rate hikes to interest rate cuts in 2019.

Chart: the RSI point of gold breaks through the overbought range, and the current increase does not rule out that it has already taken a head start.

Source: Bloomberg, China International Capital Corporation Research Department

Chart: we previously suggested that gold may be more of a phased allocation option, and the next opportunity comes from the expectation of interest rate cuts in the second half of the year.

Source: Bloomberg, China International Capital Corporation Research Department

The RMB is overbought, the scale of foreign capital return is increasing, and the growth expectation has yet to be realized. The recent marked appreciation of the RMB is mainly affected by the warming of China's growth expectations. The upward flow of capital and the return of foreign capital has also accelerated obviously. as of January 16, the net inflow of northward capital has reached 79.9 billion yuan since the beginning of the year (of which the Shanghai Stock Connect has a net inflow of 38.8 billion yuan so far this year, and the Shenzhen-Hong Kong Stock Connect has a net inflow of 41 billion yuan.). Compared with the average net inflow of less than 30 billion yuan in the same period in the past five years, the scale of net inflow is significantly larger. However, since November, more deterministic expectations have been included in the direction of economic repair, and the final level has yet to be verified by more economic data. From the transaction level, the current RMB level has also broken through the overbought range, so we need to pay attention to the possible impact of the trend of the US dollar.

Chart: from the transaction level, the current RMB level has also broken through the overbought range.

Source: Bloomberg, China International Capital Corporation Research Department

Pressure remains in some emerging markets. Under the influence of the global liquidity crunch over the past year, we have seen the exposure of regional financial risks such as the Credit Suisse incident, the UK pension incident and Sri Lankan default. For countries where domestic demand is weak, current account damage to external demand or highly leveraged countries, the pressure from the dollar crunch and liquidity tightening will be more pronounced. The recent weakness of the dollar has significantly alleviated the pressure on emerging market exchange rates and capital flows, but continued improvement needs to be supported by the inflection point of the dollar trend and the improvement of its own fundamentals.

Chart: for countries with weak domestic demand, impaired current account for external demand, or highly leveraged countries, the pressure caused by the dollar "shortage" and liquidity tightening will be more obvious.

Source: Bloomberg,Haver, China International Capital Corporation Research Department

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