FX Talking July: The dollar’s break point

It has been a long time coming, but this month’s release of US June inflation data might actually be the point at which the dollar breaks lower. Like many, we had been looking for a cyclical drop in the dollar in the second half of 2023. Now some strong evidence of US disinflation might just be the catalyst for this important market adjustment.

Within the G10 space, the biggest beneficiaries of the softer US price data have been the unloved Scandinavian currencies. These had been the biggest victims of hard landing fears. What could now be the start of some sizable bullish steepening in the US yield curve will help the pro-cyclical currencies on the view that peak rates are close at hand.

Our team looks for one last rate hike from the Federal Reserve and two further hikes from the European Central Bank. This should allow EUR/USD to better connect with its fundamentals, although we doubt that the rally will be as quick as the one seen last November-December. However, EUR/USD now has a clear bias towards 1.15 over the coming months and quarters.

Elsewhere in G10, the Bank of Japan probably needs to normalise policy further to get USD/JPY trading well under 135 – but that certainly looks to be the direction of travel. Sterling may temporarily hold gains until UK price data softens – potentially in the fourth quarter. And the Swiss National Bank will continue to manage the trade-weighted Swiss franc stronger.

Within EM, CE4 FX might struggle to rally substantially further against the euro and weak Chinese growth is proving a headwind. Yet, the EM asset class may now enjoy the strongest portfolio inflows since late 2020 and Latin currencies can continue to perform well given relatively large weightings in key benchmarks.