New video: The rising case for a “softish” landing (3:05)
The latest views from our Chief Investment Officer Mark Haefele.

Thought of the day

As investors await Friday's annual Jackson Hole speech by Federal Reserve Chair Jerome Powell, the Dollar Index (DXY) achieved its fifth consecutive weekly gain. While investors are not expecting a significant shift in the Fed's messaging, there is anxiety that Powell will underline the risk that interest rates will need to stay higher for longer—a signal that would support the US currency. The DXY index, which tracks the US currency against six major peers, has also been supported by resilient economic data and the climb in 10-year US Treasury yields to their highest level since 2007. Ten-year US real yields of nearly 2% are also at the highest point of the cycle.

But while more persistent US dollar strength is a risk, we remain cautious about extrapolating current supportive macro trends into 2024 and continue to advise investors to actively manage their exposure to the USD.

The lagged impact of past Fed tightening should contribute to decelerating growth, leading to eventual rate cuts. Our baseline is that continued drawdown of excess savings in the US, alongside elevated interest rate costs, will weigh on consumer spending, especially next year. Slowing economic growth and easing inflation should provide room for the Fed to cut rates in 2024. The rise in the headline consumer price index (CPI) slowed to 3.2% year-on-year in July, from a peak of 9.1% in June 2022, and the core CPI also moderated.

A narrowing of the US yield advantage is likely to reduce the US dollar’s appeal. We think an anticipation of rate cuts will push 10-year US Treasury yields toward 3–3.5% over the next 6–12 months, versus 4.3% currently. As yields decline, we expect investors to move funds out of the US and into higher-yielding emerging markets or formerly negative-yielding G10 currencies.

Structural factors point to a softer US dollar, including the dollar’s expensive valuation, the twin fiscal and current account deficits, the ratings outlook, and the high allocation of funds to the US. We expect such long-term drags to reassert themselves once the US growth and rate advantages narrow.

So while the US dollar has regained ground in recent weeks, we advise investors to manage long USD risks. Investors looking for diversification should still be long the euro, which is among our most preferred currencies versus the US dollar. More pro-growth-oriented investors could look to the British pound as an alternative to the euro. Investors concerned over global growth are advised to hold Swiss francs. As for the Japanese yen, we do not advise adding new long yen positions versus the US dollar at present, while existing positions should be managed to reduce yen downside risks. For more risk-tolerant investors, being long high-yielding currencies across the world should deliver positive total returns toward the year-end, in our view. We favor currencies like the Brazilian real, Mexican peso, the Czech koruna, Indian rupee, and Indonesian rupiah.

Beyond directional currency exposure, an increase in option volatility, though modest, continues to offer the opportunity to sell volatility in currency markets. From an option volatility perspective, besides the yen, we think Scandinavian (Norwegian krone) and antipodean currencies (Australian dollar) and the South African rand (ZAR) present attractive volatility-selling opportunities. This applies particularly to investors whose base currencies are the US dollar, Swiss franc, or euro.