Federal Reserve Chair Jerome Powell. AFP.
Federal Reserve Chair Jerome Powell. AFP.
The USD has been making a comeback lately, as US economic data has outperformed the rest of the world. While the CNY depreciation has slowed amid aggressive pushback by the Chinese authorities, European currencies like the EUR, GBP and CHF continued to struggle against the greenback as European growth stalls.
Major central banks are pausing amid still-elevated inflation, but the divergence in policy guidance could keep the USD supported for a bit longer. The Federal Reserve (Fed) upgraded its growth outlook and laid out a bias to potentially raise rates one more time this year while allowing for fewer rates cut next year. The Fed’s hawkish hold at the September meeting is distinct from the tone of its European counterparts, including the dovish hike by the European Central Bank (ECB), and the dovish hold by the Bank of England (BoE) and Swiss National Bank (SNB).
For the USD, it means staying supported for longer, especially against European currencies. However, there is a limit to EUR’s downside given that the Eurozone’s downgrades may have largely played out. Green shoots in China's data may well begin to be reflected in the Eurozone’s 4Q23 data releases and shift the narrative in a more positive direction. Despite the struggles of the German industrial base, it is not clear there is a permanent loss of competitiveness following the energy shock. By contrast, the US exceptionalism narrative may likely be challenged by a slowdown from 4Q23 on combination of modest negative US shocks including an escalation of the autoworkers’ strike, a looming government shutdown and student loan repayments. A slowdown in 4Q23 US data would raise doubts about the Fed's new economic outlook.
Growth gap between Eurozone and US likely past its worst, which should limit EUR’s decline
Source: Bloomberg, Citi, Bank of Singapore
With growth divergence between the US and Eurozone likely past its worst, we are reluctant to chase EURUSD lower. Our base case is that a significant slowdown in US growth over the next few quarters that brings about a Fed easing cycle ahead of the ECB will eventually pull the USD lower. However, we may need to wait a bit longer before that is clear.
Amongst the European currencies, there is still room for the GBP and CHF to weaken against the EUR. The surprise hold at the September meeting despite the UK’s underlying inflation being elevated compared to peers suggests a relatively higher inflation tolerance by the BoE. This leaves the GBP vulnerable, especially if the incoming UK data reflect a more negative growth picture. UK political risk and economic uncertainty (considering the polls currently suggest there would be a change in government) may become increasingly priced ahead of the next election and by elections.
The SNB’s dovish pivot to keep policy rates on hold this month reinforces the CHF as a better funder than the JPY. The current dovish Bank of Japan stance – which has driven the JPY weaker so far this year – seems increasingly unsustainable amid further inflation acceleration. While the SNB maintained its FX intervention commitment, we believe its tolerance for a strong real exchange rate has greatly diminished with core inflation below 2% and the Swiss economy underperforming even the Eurozone.
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