11 April 2023

FX Talking: Survival of the fittest

FX markets have started the second quarter cautiously optimistic. This is based on the assumptions that price and activity data will allow the Federal Reserve to cut in the second half – and that policymakers have done enough to restore financial stability after bank failures last month. We think the dollar will weaken this year, but timing is everything

FX Talking: Survival of the fittest

Timing the dollar sell-off is key

Two US regional banks have failed and one systemically important Swiss bank was close to the brink. Investors are rightly asking whether these events were just aberrations or the harbinger of broader distress after a decade of cheap money. What seems clear is that tighter credit conditions make a US hard landing and a sharp Federal Reserve easing cycle more likely. The question is when, not if, the dollar falls.

With core central banks still delivering one or two more rate hikes this quarter and inflation staying quite sticky, we think the dollar can probably bounce around in ranges. Hence our forecast for EUR/USD to be trading around 1.08 over the next month. Into the second half of the year, however, disinflationary trends should have become clearer, and the Fed will be acknowledging slowing activity. By year-end, EUR/USD should be trading at 1.15.

The outperformance of the Japanese yen is probably the conviction call on the back of US financial stress and a forthcoming Fed easing cycle. A further adjustment in Bank of Japan policy this June may help the yen too. Later in the year, however, higher oil prices will probably be the biggest risk to what otherwise looks like a 120 story in USD/JPY. The end of tightening cycles in many G10 economies also creates a tricky environment for commodity currencies. These should be performing better as the forthcoming Fed easing cycle is priced. Within that space, we prefer the oil exporting currencies of Canada and Norway based on our above consensus house view that Brent oil ends the year above $100/bbl.

We expect the British pound to remain relatively range-bound against European currencies. The same can be said for the Swiss franc, where the Swiss National Bank looks to be actively controlling its spot value through FX intervention on both sides of the market.

In the CEE region, the Hungarian forint and Czech koruna remain our top picks. The Polish zloty may well struggle to rally much further. Among the rest of the region, investors will watch political developments in Israel and Turkey with caution. And it even seems that South Africa’s central bank is expecting the rand to weaken.

Elsewhere in emerging markets, the Mexican peso should hold gains and strengthen further this year on the nearshoring story. The outlook is far less certain for the Brazilian real. And in Asia, it looks too early to expect a broad USD/Asia decline. Here, the external trade position is not as strong as it needs to be to deliver the broad gains in Asian currencies one normally expects as we head into a Fed easing cycle.

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