The US dollar has struggled to establish a clear direction this month, and Westpac's reading of that indecision is pointed: the flat performance is masking a slow structural shift against the currency, with fiscal and political headwinds building even as the market currently leans toward more Fed hikes.

A choppy but ultimately flat month

According to Westpac, the dollar index repeatedly traded as much as 0.5 points above its 10 July level over the course of the month before ultimately ending the period 1.5 points lower at 99.5. The bank says that indecision is notable for what surrounded it: the range held despite an elusive US-Iran deal, and despite a market increasingly positioned for the FOMC to hike into year end, amid optimism on US growth but continuing concern over inflation.

On the bank's telling, choppy, rangebound and ultimately flat price action says less about dollar strength than about a market that has yet to make up its mind. The structural pressures Westpac identifies are, in its view, building beneath the surface even as cyclical factors — chiefly expectations of further Fed tightening — dominate the near-term picture.

Euro and sterling drive the index

Euro and sterling were the primary drivers of the DXY index's moves over the past 30 days, each appreciating around 1.5 cents to $1.16 and $1.36 respectively.

That dominance is mechanical as much as fundamental: the DXY is a weighted basket of major currencies in which the euro alone accounts for roughly 57.6% and sterling just under 12%, so EUR/USD above all tends to set the index's direction.

Westpac says these levels are not historically demanding for either currency, and that the balance of risks facing both the eurozone and the UK is turning more favourable on growth and inflation. In other words, the recent appreciation has not left either currency stretched by historical standards, while the fundamental backdrop for both economies is improving in the bank's assessment.

Targets out to end-2027

On that basis, Westpac targets EUR/USD at $1.21 and GBP/USD at $1.39 by the end of 2027. Beyond that horizon, the bank expects each currency to plateau rather than extend its advance indefinitely. After 2027, its base case has both majors settling once the adjustment it envisages has run its course, rather than a continued one-way appreciation.

The end-2027 horizon also reflects the pace of adjustment the bank envisages — a gradual drift rather than a sharp dislocation, absent the risks it flags actually crystallising.

A structural argument, not a cyclical one

Westpac's underlying argument for why this trend continues — and why the balance of risks should shift increasingly against the US over time — is more structural than cyclical.

The first element is economic breadth. The bank points to an extended period of US economic outperformance that has increasingly relied on a narrowing base, suggesting the run may not be sustainable.

The second is political. Westpac draws a contrast between what it describes as a striking degree of common purpose in Europe around defence and economic development, and the ongoing partisan turbulence in the United States.

The third is fiscal. Government debt is a live issue across all three jurisdictions, Westpac notes, but the bank argues that the structural imbalance in the US budget position stands apart. That imbalance is compounded by rising US debt service costs — a burden that has grown as maturing Treasury debt rolls over at the higher rates of recent years, making interest payments one of the fastest-growing federal outlays — and by growing market unease over the Federal Reserve's diminished forward guidance. Taken together, these constitute larger financial headwinds for the dollar than for either the euro or the pound.

Notably, Westpac frames these forces as headwinds that compound over time rather than resolve quickly. That framing explains the shape of its forecast: targets extended out to end-2027 rather than a call on a near-term top for the dollar.

History frames the dollar as stretched

Westpac closes by putting the dollar's current level in longer historical context, and it is here that the bank offers its most provocative detail for positioning purposes.

The DXY index's 10-year average sits around 1% below current spot levels — a relatively modest gap. The 20-year average, however, sits almost 9% lower. That window includes the dollar's slide to a lifetime low below 72 in 2008, the kind of extended weak-dollar phase that pulls the long-run average down and frames how far current levels sit above it. That widening historical gap frames current dollar strength as historically stretched, and Westpac says it implies a material chance of an outsized market move should the risks it has identified against the US actually materialise — a far sharper repricing than the gradual drift implied by the bank's own base-case targets.

Against that longer-run backdrop, the end-2027 targets represent the gradual path, while the historical gap outlines what a sharper path could look like if the bank's risk scenario plays out. Which path prevails rests on the very factors Westpac enumerates — the breadth of US growth, the US fiscal trajectory, and the political contrast with Europe — unfolding slowly or instead all at once.

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Earlier from WPAC: Joint US-Japan Intervention loses grip as USD/JPY climbs back above 159