Source: AFP
Source: AFP
The USD has weakened faster than we envisaged. Unresolved risks such as corporate earnings disappointment, pushback by a frustrated Federal Reserve (Fed) against premature loosening of financial conditions and a bumpy China reopening could temporarily stall the USD’s decline. But we believe that the USD’s correction lower has room to run.
Despite weakening faster than expected, the USD’s correction lower has room to run
US dollar index refers to BIS US Nominal Effective Exchange Rate Narrow.
Source: Bloomberg, Bank of Singapore.
Various factors that were previously amplifying USD strength seem to be reversing. Firstly, growth outside the US appears less dire than feared. The faster-than-expected reopening of China and the reversal of Europe’s energy shock thanks to proper preparation and some luck have fuelled hopes that the global economy could be heading for a soft landing. Secondly, uncertainty over policy and inflation is also fading as signs of disinflation continue to mount. Inflation becoming less of a problem has not been just a US phenomenon: the share of countries with favourable CPI misses has increased thanks to lower commodity prices and tighter policy stance. Thirdly, the USD’s yield advantage is being eroded by higher yields abroad. Cooling US inflation should pave the way for the Fed to step down the pace to 25bps hikes in February while the European Central Bank and Bank of Japan (BoJ) have moved in a more hawkish direction.
The debt ceiling is a renewed risk to watch for. It is increasingly likely that debt ceiling risks return to the fore later this year once the US Treasury exhausts its extraordinary measures.
Phases of USD strength that slow the USD decline in the next 3-6 months are still possible if US economic resilience comes back into focus and if the Fed bucks market expectations of rate cuts later this year. We see the Fed hiking 25bps hikes in February, March and May before pausing. We do not expect the Fed to cut rates later this year given the stickiness of inflation.
Since the surprise policy tweak by the BoJ in December, markets have increasingly priced in greater odds of an abandonment of yield curve control. USDJPY can drop further in 6-12 months’ time on the back of expectations of monetary tightening by the BoJ and disinflation hope in the US.
As China’s reopening rapidly gains traction, other Asian currencies (e.g KRW, THB and increasingly the IDR, MYR) and China-sensitive currencies like the AUD stand to benefit more than the CNY. The likely pickup in outbound travel should benefit Thailand and Malaysia, which were major tourist destinations for Chinese travellers pre-pandemic. Particularly good news for the AUD has been the easing of the “three red lines” in the residential property as well as measures designed to help first-time home buyers. These measures will help stabilise the very weak residential property market, a sector which, by consuming 20% of Chinese-made steel, has helped lift iron ore prices. Amongst the G10 commodity currencies, we are positive AUD, neutral CAD and negative NZD.
CNY, too, has benefitted from the faster-than-expected reopening. However, further CNY strength is likely to be moderate, as China’s trade surplus narrows, outbound travel picks up and on the back of the CNY’s yield disadvantage relative to the USD.
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