FX Talking: Dollar appetite erodes

It has been a bumpy start to the year for FX markets, but one central theme remains – appetite for the dollar is waning. The strong demand for pro-cyclical currencies, including the euro, is one factor drawing money away from the US. But the uncertainties about future Federal Reserve policy and what the investment environment could look like ahead of this November’s US midterm elections has also been eroding confidence in the dollar. That is certainly the message from the options market, where dollar puts are in demand.

What has not changed much, however, are the fundamentals behind the dollar. US growth remains reasonably strong, and a softening US labour market prompting two Fed rate cuts should be consistent with a dollar dip, not a collapse. Unless the outlook for US bond and equity market returns deteriorates substantially (not our base case), we continue to favour EUR/USD edging up to 1.22 area in an orderly manner. And any overshoot to 1.25 could well prompt a European Central Bank rate cut.

Elsewhere in G10, we look for USD/JPY to bounce around in a 155-160 range until the dust settles on what the newly empowered Liberal Democratic Party government means for the JGB market. Sterling looks a clear underperformer on both local politics and a Bank of England ready to move ahead with more rate cuts. The commodity complex should continue to perform well this year, although we favour the New Zealand dollar and Norwegian krone over the Australian dollar and Swedish krona this quarter.

Emerging market FX should remain in demand. USD/CNY is approaching the lower end of our 2026 trading range at 6.85 much sooner than expected. Trade deals suggest USD/INR might have finally topped. And CEE currencies are expected to hold gains.