FX Talking: Competitive revaluations

2022 should prove a year in which strong currencies are more broadly favoured as a means to address high inflation. We are not in the camp arguing that the dollar has peaked. Instead, we see room for the Fed terminal rate to be priced above 2.00% and the dollar to strengthen further – especially through Fed lift-off in 1H22.

Unlike the more familiar currency wars, which were fought through periods of deflation, the inflationary environment of 2022 should mean that currencies are viewed through the lens of how the inflation shock is handled. Pro-active, hawkish central banks will deliver flatter yield curves, more expensive FX hedging costs and stronger currencies.

Into this camp we would put the dollar, energy exporters (backed by strong business investment) and selected European currencies, such as GBP, CZK and PLN. And it has been a surprise to see the CHF doing well – even the SNB seems to welcome FX strength.

As usual politics will never be far from FX markets. We note European political event risk in Italy (January) and France (April) which can help EUR/USD down to the 1.08/1.10 region in 2Q. April elections in Hungary may temporarily cool the jets of Forint bulls too.

Geopolitics on the Ukraine/Russian border also presents substantial uncertainties. It is certainly not a baseline scenario, but the events of late 2014 remind us of the liquidity gaps and USD hoarding that led to a substantial drop in the Ruble at that time.

Latam also sees political risk in the form of Brazil elections and a new left-wing President in Chile – we favour Mexico here. Asia looks more stable as it emerges from Covid.