None of this is good news for the US dollar, which we expect to travel along a weaker path, with limited and short-lived bouts of strength.
The Fed is getting closer to the end of its rate-hiking cycle. The peak in interest rates now seems closer for the Fed than others, as both the European Central Bank and the Bank of England are expected to raise rates by 50bps this week to fight still-elevated inflation. With markets growing comfortable with a terminal fed funds rate close to or at 5%, and US inflation likely to quickly roll over in the first half of this year, downward pressure on the USD should continue to mount.
Reduced carry advantage could weigh on the dollar over the medium term. Last year, an increasing US-Germany 10-year interest rate differential was a tailwind for the strong dollar rally. However, the yield differential is likely to be less supportive this year. Based on data since 1990, the euro rose 1.5% against the dollar when the yield differential fell over six months and 2.1% over 12 months.
Better growth outlook ex-US supports other currencies. Recent economic data points to a diverging global growth outlook—the US economy continues to decelerate due to aggressive rate hikes in the past year, while Europe and emerging markets appear more resilient thanks to lower gas prices and China’s reopening. We believe that a rebound in global growth expectations for the second half of 2023 and 2024 should support the euro and the currencies of Asia’s major exporters.
We suggest avoiding long greenback positions, and recommend setting exit levels to curb excessive long USD exposure. Investors can also consider shorting the USD versus the NZD and the AUD, which we rate as most preferred in our global strategy.
Main contributors - Mark Haefele, Daisy Tseng, Dominic Schnider, Christopher Swann
Content is a product of the Chief Investment Office (CIO).
Original report - US dollar on weaker path despite further Fed rate hikes, 30 January 2023.