investment insights

    Dollar strength broadens out

    Dollar strength broadens out
    Kiran Kowshik - Global FX Strategist

    Kiran Kowshik

    Global FX Strategist
    Homin Lee - Senior Macro Strategist

    Homin Lee

    Senior Macro Strategist
    Sophie Chardon - Cross-Asset Strategist

    Sophie Chardon

    Cross-Asset Strategist

    Key highlights

    • Potential escalation in the Russia-Ukraine conflict and global growth downgrades should keep the US dollar (USD) well supported. We lower our forecast for the euro (EUR) against the dollar to 1.02 and raise our forecast for the dollar against the Japanese yen (JPY) to 135. Risks are for a stronger USD
    • The first quarter was predominantly about relative terms of trade shifts, with currencies of commodity exporters being rewarded at the expense of commodity importers
    • Now, dollar strength is broadening out, which suggests further differentiation may have to wait as the greenback reigns supreme
    • The renminbi’s (RMB) breathtaking stability until Q1 has now ended, with USDRMB now re-calibrating to a stronger dollar. We pencil in a 6.70 – 6.90 range for USDRMB and would consider further downgrading our RMB view if China’s exports slow more than expected
    • We expect gold prices to remain volatile and trade broadly within USD1,900-USD2,000/oz in the short-term
    • In oil markets, supply-demand dynamics remain stretched, and we foresee a further price spike looming in the fourth quarter of 2022.

    The US dollar rally has broadened out: what started in Q1 as a divergent dollar (gaining ground versus commodity importers but softening versus exporters) has now become more uniform strength. The reasons, in our view, include a mix of an escalation in the Ukraine-Russia conflict and further Chinese growth downgrades.

    On the first driver, our central case scenario for the Russia-Ukraine conflict was one of “prolonged conflict” i.e. where the fighting carries on but remains largely localised to the eastern part of Ukraine. Moreover, we assumed that while concerns over reduced energy supply would keep prices higher, gas would still continue to flow to Europe.

    Under this “base case” we had pencilled in EURUSD reaching 1.06. That said, recent events suggest that the possibility of moving to a worsening “war intensification and gas disruption” scenario has increased. Such a development would be even more EURUSD negative and would result in the pair breaking parity, in our view. Applying a higher probability for such a tail risk scenario, we settle on a new EURUSD forecast of 1.02, but risks are very much for further USD strength. Furthermore, our updated model estimate for EURUSD now stands at 0.98 (versus 1.05 prior), following the recalibration in expectations on US yields and the Fed's accelerated monetary policy tightening.

    We settle on a new EURUSD forecast of 1.02, but risks are very much for further USD strength

    As for the second driver, renewed lockdowns in China, as well as signs of increasing supply-chain disruptions, have resulted in a worsening global growth outlook. While the RMB has been extremely stable over Q1, USDRMB has since risen sharply, while seeing little pushback from the Chinese authorities. We assume a 6.70 – 6.90 range for now for USDRMB, but would further downgrade the RMB view if there were more concrete signs that the country's super strong trade surplus was being affected. We view the USDRMB rise a recalibration to a broader USD strength rather than a move to devalue the RMB (like in 2015). Nevertheless, it will have negative ramifications for several currencies.

    Finally, we would point out that the two developments cited above will not only pose risks to growth, but also upside risks to inflation, as they affect supply chains. Central banks have shown that they are placing more emphasis on upside inflation risks than on lower growth risks, and are likely to remain hawkish. To the extent that this results in global liquidity shrinking at a faster pace, the greenback is likely to remain very well supported. We also do not find obvious signs that there is too much USD bullishness “in the price” when we survey relevant sentiment indicators.

    For more in-depth analysis on global and developed market currencies, oil and gold, please read our full FX Monthly publication, which is downloadable on the right-hand side of your screen.

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