The dollar's resilience to disappointing US economic data stems from the market's low starting point for Fed rate hike expectations (less than two hikes priced in). This creates a high bar for further dovish repricing, effectively putting a floor under the currency.
The dollar has shown a renewed negative sensitivity to "twist steepening"—when long-term yields rise while short-term rates remain stable. This makes the dollar vulnerable to factors that push up the term premium, such as political uncertainty, without the support of hawkish Fed policy.
Despite endless debate on the dollar's direction, the most profitable FX strategy is the simple carry trade, which has generated 6-12% year-to-date returns. In a pro-cyclical, low-volatility environment with wide yield gaps, focusing on yield differentials is more effective than making binary calls on major currencies.
Currencies like the Swedish Krona or Canadian Dollar face an insurmountable hurdle. Even with improving domestic growth, they cannot rally sustainably because the market is singularly focused on carry. Their yield disadvantage relative to the dollar is a dominant headwind that positive local news cannot overcome.
Conventional Bank of Japan rate hikes are insufficient to stop the Yen's decline. A true stabilization requires a "sea change" in policy, including unorthodox government measures like mandating domestic bond purchases by life insurers or creating new tax incentives for retail JGB purchases.
The market's view on whether the Bank of Japan is "behind the curve" is directly reflected in the shape of Japan's short-term yield curve. A flattening curve suggests the market believes the BOJ is becoming more credible, a key indicator and prerequisite for potential yen strength.