USD, risk of further upside trajectory

Fed is kept in play for a first rate increase at the next meeting on 17 September with a 2.3% increase in Q2 GDP, and a rise in the core GDP deflator to 1.8%. Futures markets are pricing in only 14bp which leaves considerable risk of a sell off if incoming data harden the case in the next few weeks for a move in September.

The front end of the US yield curve, i.e. 2y and 5y cash and swap rates would traditionally bear the brunt of the sell-off relative to the long end, resulting in a bear flattening of the curve.

Though the US dollar has this year appreciated back to its historic 15-year average in real terms, the psychological shock of a first rate increase by the Fed, and uncertainty over the rate path thereafter, will underpin the USD against emerging market and commodity currencies more generally.

"Fears that a crisis similar to that of 1997 could repeat are based on the fact that total and foreign currency debt levels (i.e. USD) have risen sharply in the non-financial sectors of many emerging market countries, mainly Asia and LatAm", says Societe Generale.

As the IMF illustrates in its 2015 Spillover report here, in some countries, the ratio of corporate debt-to-GDP is close to levels seen during the Asian financial crisis. Highly leveraged corporate sectors tend to have higher FX exposure. When US interest rates rise and the US dollar appreciates, the risk of a US debt shock increases in particular if growth in the domestic economy slows. 

"The same is true for oil/commodity exporting economies where falling dollar revenues are hurting fiscal revenues and public finances, putting pressure on sovereign ratings and investment flows. Though the dollar may be trading close to fair value, the risks are skewed to further upside until we get the first rate increase by the Fed out of the way", added Societe Generale.