COMMENT-U.S. dollar strength dims as key drivers weaken

U.S. dollar strength is waning due to weakening drivers of risk aversion and policy divergence.

While concerns about inflation have delayed and reduced expected U.S. rate cuts, last week's U.S. CPI data has prompted a reassessment. Reassessments are also occurring in other major economies including the European Union and Britain, where officials are cautious about premature policy loosening.

Tensions between Iran and Israel heightened last week, temporarily boosting the USD due to increased risk aversion, but widespread calls for de-escalation have helped restore risk appetite. Additionally, a tri-nation statement by the U.S., Japan, and South Korea on mitigating further losses against the USD signals potential interventions to stabilize the JPY and KRW.

In the FX options market, a rush to cover short positions and adopt long volatility strategies rapidly boosted premiums this week. However, implied volatility is falling sharply now and indicates dwindling USD momentum, improved risk appetite and a current lack of FX realised volatility.

While the possibility of returning drivers remains, a period of calm in the Middle East and before upcoming policy data could leave the USD to stabilize below recent peaks.