Brexit predictably caused the USD to rally, as any global risk-off episode will do.  However, we reiterate our view that the USD will have a tendency to weaken, after the current rally dies out (which it already appears to be doing, with the DXY basically going nowhere since the day after the referendum result).

We identify four drivers of the dollar which still do not point to a stronger USD.  1) UST yields continue to stay low.  2) Rate expectations remain very subdued, with the Fed’s reaction function now so weak OIS briefly priced in a negative Fed rate after Brexit (see chart).

img1Source: Macrobond, Bloomberg and Variant Perception

3) Capital inflows to the US remain low – there may be some pick-up in the wake of Brexit, but inflows are considerably lower than where they were in 2014/15.

img2

Source: Bloomberg and Variant Perception

And finally, 4) negative carry: the US is one of the few G20 economies with significantly negative real rates (bottom chart).  We would sell dollar rallies, especially against EM currencies.

img3

Source: Bloomberg and Variant Perception