perspectives d’investissement
Forex in transition
Key highlights
- We believe the FX market is in transition to what will be a firmer US dollar and modestly lower euro-dollar over 2022.
- Important drivers likely to support the dollar include incrementally less dovish global central banks and hence somewhat tighter global liquidity, a moderation in the pace of global growth (to still good levels), as well as the energy crunch.
- In the months ahead, the dollar will strengthen against the yen and several emerging market currencies.
- The euro should be weaker on the crosses driven by a softer balance of payments, and notwithstanding a still relatively dovish European Central Bank.
- We explain why the Swiss franc could remain stronger for longer vis-à-vis a weaker yen, and the tell-tale signs we will be monitoring.
- Sterling should remain supported on a three-month view. We believe it is too early to sell the currency based on a “Bank of England policy mistake” argument.
- Emerging market currencies as a whole remain vulnerable, however the renminbi should hold up quite well despite Chinese growth concerns.
Our prior outlook on the US dollar was more bearish, based on still-strong global growth, which tends to weaken the US dollar (USD), as well as a Federal Reserve Bank (Fed) that was willing to stay accommodative for longer and tolerate a modest inflation overshoot.
That said, on both these counts, there have been notable changes.
First, the global manufacturing PMI, while still above 50, peaked in May and has been grinding lower. A likely slowing of Chinese growth into year-end and modestly less stimulatory global liquidity suggests that the era of EURUSD overshoot may be over.
Second, just as global money supply is coming off the boil, the “inflation being transitory” narrative is increasingly being tested, resulting in an incrementally less dovish tone coming through. For the Fed, “tapering is in the bag”. However, our base case is that the first interest rate hike remains some way off, i.e. in 2023 at the earliest. Markets are responding to incipient signs of rising core inflationary pressure and less dovish Fed rhetoric. This dynamic may have some months to run still, keeping yields elevated and supporting the USD.
Third, our call for higher energy prices on a three- to six-month view should see the US dollar hold up far better than many other energy-importing G10 currencies. Remember, the US is no longer an energy importer, and hence will not be vulnerable to supply crunch-led rallies in energy prices.
Taken together, we pencil in EURUSD staying range-bound with downside risks into year-end (1.16 Y/E target), and see a gradual decline in 2022 (1.12). USDJPY will likely end the year around 116 before declining towards 112 in 2022.
The renminbi (RBM) should hold up well against the non-USD currencies; however, USDRMB will likely trade in a sideways 6.35 - 6.50 range and move higher in H2 2022 as a number of post-Covid flow supports wear off, assuming outbound travel normalises. However, we stress that we still expect the RMB to perform well against the EUR.
There will be ups and downs within the EURUSD grind lower that we envisage. It is plausible that at some point in Q2, a normalisation of the energy crunch, delayed impact of the US fiscal cliff on activity, and stabilisation of Chinese data will result in EURUSD being better supported. However, this is likely to be temporary, in our view.
However, aside from the dollar, we believe a number of other themes will dominate into year-end, such as EUR weakness on the crosses, yen underperformance vis-à-vis a better supported CHF, a stronger Sterling into year-end, as well as a still-stable RMB against several depreciating emerging market currencies.
As for the risks to the downside for the US dollar, the most prominent would be the signs of strong recovery in the pace of global growth, likely preceded by a notable improvement in Chinese credit growth in the remainder of 2021. Other important downside risks include the Fed emphasising that it is comfortable allowing for a further overshoot of core inflation (hence pushing back on rate hike pricing), and an earlier resolution of the supply crunch in energy commodities.
On the risks to the upside for the dollar, we note signs that the global growth moderation is more than a simple normalisation back to trend, as well as indications that Chinese credit policy will remain tighter for somewhat longer as authorities focus more on containing leverage and reducing income inequality. From the US side, we flag the Fed giving a stronger nod to rising core-inflationary pressures while de-emphasising the goal of full employment. This could allow for early rate-hike pricing to build vis-à-vis our baseline for a 2023 rate lift-off.
Lastly, we mention continued tightness in energy markets beyond Q1 22.
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