The current USD rally is happening at a time when the US economy is weakening. Historically a weak US economy would have been seen as negative for the USD.
Since the crisis, the market has had to come to terms with new rules. One of them that seems to go against the “fundamentals” is that a weak US economy is not necessarily USD negative.
We have suggested that the FX market has lost its anchor of reason and this still seems to be the case. The confusion for the FX market is even greater when we take into account the US debt ceiling issue. In the pre-crisis world, if the debt ceiling were raised to help offset a slowing economy by boosting fiscal spending, then it would be USD supportive. In the post-crisis world, an increase in the debt ceiling will help reflate risky assets at the USD’s expense.
The “fundamentals” used to say that the USD had primacy, but now the USD behaves like a residual currency. Fundamentals are working; just in a different manner.
HSBC Global Research