HSBC has identified a sharp appreciation in the US dollar as one of the most significant potential pain trades for investors in the second half of 2026, arguing that markets remain vulnerable to a stronger-than-expected move in the currency, according to a report Bloomberg.

In a report published on 29 June, the bank said it expects the dollar to continue strengthening into the first half of 2027. However, strategists warned that the move could accelerate rapidly if the Federal Reserve adopts a more hawkish policy stance than investors currently anticipate or if geopolitical risks intensify.

According to HSBC, the risk of an outsized dollar rally has increased since the Fed's June policy meeting. Policymakers maintained a firm focus on inflation while providing little indication that interest rate cuts are imminent, prompting markets to refocus on rate differentials in support of the greenback.

Strategists led by Paul Mackel said an unexpectedly strong dollar would represent a significant challenge for investors, particularly if the rally gathers momentum over a relatively short period.

The bank's view comes after the Bloomberg Dollar Spot Index reached a seven-month high earlier this month, supported by resilient US economic data and expectations that US monetary policy will remain tighter for longer. At the same time, prospects for further policy tightening in other major economies have weakened, with softer growth expectations in Europe and continued pressure on the Japanese yen amid expectations the Bank of Japan will proceed cautiously with additional rate increases.

Investor positioning has also shifted in favour of the US currency, with hedge funds increasing long-dollar positions to their highest level in 16 months, reflecting growing confidence that the rally has further to run. HSBC also highlighted the US Treasury market as another potential source of positioning risk. At the start of the year, investors broadly expected the yield curve to steepen as the Federal Reserve continued easing monetary policy. Instead, persistent inflation, a resilient labour market and a more hawkish Fed have resulted in further curve flattening, with two-year Treasury yields rising substantially more than longer-dated maturities.

While many investors remain positioned for additional flattening, HSBC cautioned that a material slowdown in economic activity could force the Fed back towards rate cuts, prompting a reversal in positioning and a renewed steepening of the yield curve. Strategists led by Dhiraj Narula said such a shift could emerge as another notable pain trade for markets.