investment insights

Weak growth, elevated inflation to support dollar

Weak growth, elevated inflation to support dollar
Kiran Kowshik - FX Strategy

Kiran Kowshik

FX Strategy
Homin Lee - Macro Strategist - Asia

Homin Lee

Macro Strategist - Asia

Key highlights:

  • The degree of USD strength is unprecedented in the past twenty years, and a simple mean reversion argument would suggest the dollar will peak and roll over
  • However, historically, the USD has performed strongly in the presence of three factors: global inflation over 5% year-on-year, global growth slowing, and central banks tightening policy. This last occurred in the 1980s
  • Given the current global macroeconomic landscape of weak growth and elevated inflation, long USD exposures make sense in a portfolio context
  • We maintain our 1.02 and 1.35 targets for the EURUSD and USDJPY respectively. However, we lower our forecast on sterling further to reflect the currency underperforming even the euro. We now target GBPUSD at 1.16 (versus 1.22 previously)
  • Emerging market currencies could remain more vulnerable as dollar strength broadens out. We still prefer Latin America to Asia, and the most challenged region in our view is Central and Eastern Europe, the Middle East and Africa.

Except for a short-lived but sharp pull-back in the second half of May, the US dollar (USD) has stayed strong into June, even exceeding the high set earlier in May.

By all accounts, the degree of USD strength has been unprecedented in the past twenty years, and under normal circumstances, a simple mean reversion argument would suggest the dollar would peak and roll over.

But these circumstances are far from normal, and we believe the dollar will remain strong, as macro forces more resemble a stagflationary situation.

Our analysis indicates that historically, the USD has performed strongly in the presence of three factors: global inflation over 5% year-on-year, global growth slowing, and central banks tightening policy.

The environment will dictate which currencies will be most vulnerable. Much of the first half of 2022 was largely about USD strength against commodity importers (like the euro and sterling). However, already there are signs that the USD rally is expanding to affect commodity exporters as well (like the Australian and New Zealand dollars).

Much of the first half was largely about USD strength against commodity importers; already there are signs that the rally is expanding to affect commodity exporters as well

Traditional haven currencies like the Swiss franc and Japanese yen could remain volatile as markets transition from pricing high inflation (and central bank tightening) to a possible US recession on a six to twelve-month view.

Of the two haven currencies, the Swiss franc (CHF) remains our favourite hedge given its superior balance of payments. The franc received a boost following an unexpectedly hawkish Swiss National Bank meeting. The central bank indicated a preference for a strong and stable CHF, and suggested that it may consider foreign currency selling interventions to keep the EURCHF low.

Of the two ‘haven’ currencies, the Swiss franc (CHF) remains our favourite hedge given its superior balance of payments

This month, we have lowered our forecast on sterling further to reflect the currency underperforming even the euro. We now target GBPUSD at 1.16 (versus 1.22 previously).

Emerging market currencies could remain more vulnerable, requiring differentiation among them. We still prefer Latin America to Asia, and the most challenged region in our view is Central and Eastern Europe, the Middle East and Africa (CEEMEA). We continue to believe the Brazilian real (BRL) could outperform and add value, especially for EUR-based investors.

To read more on our currency views and forecasts, please download our full ‘FX Monthly’ publication in the top right-hand side of the screen.

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This is a marketing communication issued by Bank Lombard Odier & Co Ltd (hereinafter “Lombard Odier”).
It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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