15 August 2022

FX Talking: Curb your peak dollar enthusiasm

Having corrected 3% lower, some are asking whether the dollar has peaked. In this August edition of FX Talking, we argue that the dollar is more likely to retest its highs than correct much lower. A dollar turn requires convincing evidence of a reversal in the Fed cycle, plus some attractive investment destinations overseas. Neither looks likely this year

Executive summary

The dollar has corrected around 3% from its highs seen last month. This has prompted a few questions about whether the dollar has peaked. Many trading partners would hope that to be the case, but the reality is that the Fed is likely to stay on track with its tightening. We think the dollar is more likely to retest its highs than correct much lower.

Driving this view has been consistent rhetoric from the Fed that it will not be blown off target by some softer activity or price data. In fact, it now looks like US activity is accelerating again as lower gasoline prices leave more dollars in the pockets of US consumers. The 2023 US recession narrative looks a tough one to sell near term.

And rising energy prices should continue to drive a wedge between the exporters of North America and the importers of Europe, meaning a much greater conviction of a recession in Europe. The ECB's second 50bp rate hike on 8 September may well conclude its tightening cycle. Rate spreads and the energy income shock make it a very tough environment for the euro. EUR/USD should therefore drift near parity for much of 2H22.

Elsewhere in Europe, the Swiss franc continues to be guided higher by the Swiss National Bank. Sterling remains vulnerable to recession fears. Beyond some substantial fiscal stimulus, sterling’s best hope is that the Bank of England delivers on most of the aggressive tightening currently priced into markets. Surging gas prices also spell trouble for the CEE4 currencies. The Polish zloty in particular looks unlikely to hold recent gains.

Emerging market currencies have enjoyed a mini-renaissance over the last month. But a difficult external environment makes it hard to sustain those rallies until the dollar turns.

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