investment insights
Dollar to gain a stronger footing
Key highlights
- Three major drivers have affected currency markets since November: the emergence of the Omicron variant, validation by the Federal Reserve (Fed) of more hawkish expectations, and the slump in energy prices.
- At the margin, this has increased our confidence in our bearish stance on the euro (EUR) versus the US dollar (USD), and we maintain our bearish EURUSD view targeting 1.12 by mid-2022; we now however pencil in further declines to 1.09 by year-end.
- These events also make us more comfortable regarding our call for a relatively resilient Chinese renminbi (RMB) against an increasingly volatile picture for emerging market currencies.
- However, our conviction as regards our call for a higher US dollar against the Japanese yen (JPY) on a three- to six-month view and for the relative resilience of select currencies in the G10 commodity and Scandinavian bloc is now less strong.
Numerous developments have occurred in late November and early December, including the emergence of the Omicron Covid variant, validation by the Federal Reserve of market expectations for a swifter taper and rate hikes for 2022, and a large sell-off in energy prices. Currency volatility has picked up sharply, as is evident from the sharp swings in EURUSD: down from 1.16 to 1.12 in a span of weeks, and now bucking the 1.14 mark. The large number of uncertainties suggest wider currency swings should be expected from here.
The gravity of the new Covid strain remains a mystery, and as details on transmissibility, virulence, and ability to evade immunity acquired from vaccines or from prior infections may take time to ascertain, our guess is that risk sentiment will remain fragile in the weeks ahead – and conviction low.
These developments, at the margin, have made us more confident of our call for a lower EURUSD. We maintain our 1.12 assumption for EURUSD by mid-2022, but now pencil in further declines to 1.09 by the end of 2022. The dollar can indeed gain against the euro from two angles. Assuming virus uncertainties fade, the dollar will be well supported by rising Fed rate expectations, with the European Central Bank (ECB) remaining slow to tighten policy. On the other hand, should these uncertainties escalate, further downward revisions to global growth – already underway since Q3 2021 – should see the USD well bid. A much more positive re-rating of global growth prospects would put our negative EURUSD view at risk.
At the same time, the evolving backdrop increases our conviction that the RMB will remain relatively resilient for longer, as China’s zero-Covid policy is extended against a fragile emerging market currency outlook – even though selective opportunities could arise.
That said, our conviction is notably lower in two other areas: safe havens and the G10 commodity bloc.
On the former, we had assumed that higher energy prices and US treasury yields would take USDJPY up to 117 (Q2 2022) before it declined to 112 (end-2022). The first part of this assumption now seems optimistic, and our forecast faces some downside risks depending on how the virus situation and energy outlook evolve. A 111-115 range seems far more sensible at present.
Similarly, while we had already revised EURCHF lower and signalled a “low for longer” view back in October, the cross has already dipped under our assumed 1.05-1.08 range, with few hints of a pushback from the Swiss National Bank. At the same time, the bulk of this move occurred before virus-related uncertainties re-emerged. Accordingly, we opt to lower our EURCHF targets, pencilling in a 1.02-1.06 range.
The greater perceived risk from Omicron could see the downward revisions of global growth forecasts already underway since mid-2021 persist over Q1, but with greater intensity. (There is however a possibility for some snap-back if virus uncertainties fade at some point.) Energy prices will likely be softer than we had assumed on a three- to six-month basis, with recent developments on the supply side unhelpful (see Commodity corner section for more). Simultaneously, while some signs are emerging that Chinese authorities are working to cushion the downturn in the property market, the steps are being taken at a rather gradual pace to placate market concerns over slower Chinese growth.
All these forces would plead for a more cautious stance over Q1 for the small open economy currencies, including sterling and Scandinavian and G10 commodity currencies (GBP, NOK, SEK, AUD, CAD, and NZD).
You can download our full publication (the final FX Monthly for 2021) by clicking on the pdf in the right hand of your screen.
We wish you a happy holiday season and a healthy and prosperous new year.
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