Why has the dollar not strengthened noticeably despite pressure on markets?

  • The dollar’s performance was mixed this week, with limited overall volatility. Goldman Sachs believes market assessments of future capital spending are influencing the dollar: over the past year, AI investment and earnings growth have supported both US equities and the dollar; if growth expectations weaken, both could come under pressure.
  • Divergence among currencies has been more pronounced than the dollar’s overall move. Higher energy prices have benefited the Australian dollar, Canadian dollar and Norwegian krone; South Korea has seen its terms of trade improve through AI demand, and the won has also remained resilient recently.
  • Goldman Sachs’s baseline scenario is for easing inflation, slightly cooler growth and relatively synchronised G10 policy, consistent with low volatility and a moderately weaker dollar, especially against emerging-market currencies with high interest rates or relatively stable exchange-rate management. If a technology-stock correction is brief and concerns about European sovereign credit resurface, the euro would instead come under pressure and the dollar would gain support; Goldman Sachs considers this tail scenario more likely than a sustained contraction in AI investment.

Why is the yen better suited to hedging a slowdown in AI investment?

  • The key is how the shock is transmitted: downward revisions to AI capital spending or earnings expectations could send US equities and Treasury yields lower together, a combination that is usually most favourable for the yen. Goldman Sachs therefore sees a longer-term short position in dollar-yen as an effective hedge against a broad growth slowdown or an AI shock.
  • The cost of holding yen could also ease. Compared with the past six or seven years, there are signs that the yen has depreciated less when yields have risen recently; Goldman Sachs attributes this to reduced depreciation pressure from Japanese policy, combined with intervention risk limiting declines. Yen positions still carry a negative interest-rate differential cost, however.
  • Recent safe-haven performance has been inconsistent: the yen outperformed other G10 currencies on 14 October and the 22nd, but lagged on the 15th and 16th, with higher energy prices and a relatively hot US CPI reading complicating the picture. In the short term, Goldman Sachs prefers a short position in euro-yen; the Bank of Japan faces a high bar to exceed the market’s existing hawkish expectations at its 30 October meeting.

What supports renminbi appreciation, and what policy element needs strengthening?

  • After appreciating rapidly in September, the renminbi has recently returned to a steadier pace of appreciation. China’s non-seasonally adjusted trade surplus reached 133.5 billion dollars in September, a monthly record; Goldman Sachs believes weak domestic demand, strong export competitiveness and an undervalued exchange rate have kept net exports contributing substantially to growth.
  • Goldman Sachs believes market consensus and forward prices underestimate the scope for continued renminbi appreciation, and maintains its 12-month dollar-renminbi target of 6.40. But economic rebalancing requires currency appreciation alongside support for domestic demand: the former adjusts external prices, while the latter supplements domestic demand; appreciation alone is insufficient to resolve the economy’s challenges.

Which way could the US midterm elections push the dollar?

  • Goldman Sachs is watching two policy paths that point in opposite directions: an escalation involving Iran could push up energy prices and yields, supporting the dollar; tighter AI regulation, if it slows investment and construction, could depress yields, US equities and the dollar while benefiting the yen. Neither risk is highly sensitive to the election outcome itself.
  • Even if Democrats win both chambers of Congress, the dollar’s decline could be limited: legislation takes time, and expectations of higher fiscal spending would also cushion the fall. By contrast, Republicans retaining control of both chambers would deviate further from current expectations; if accompanied by expectations of less AI regulation and concerns about escalation in the Middle East, the dollar would have stronger upward momentum.