Dollar temporarily on the loose
At its June meeting, the Fed surprised the market by shifting towards a more hawkish stance. Having previously been hurt by very accommodative comments from Fed officials (despite rising inflation), the dollar soared.
We had been expecting the Fed to turn more hawkish later during the summer. But last week’s Fed meeting has brought this dollar-supportive shift forward as the markets reprice the central bank’s policy-rate path. Additional strong data in the US (especially labour-market data) could support the US dollar further in the coming months. As a consequence, we are changing our three-month projection for the EUR/USD rate to USD1.17 from USD1.21.
However, while rate and growth differentials may support the dollar in the short term, we continue to expect that a Fed content to stay behind the curve and a narrowing of the US’s economic outperformance relative to the rest of the developed world should weigh on the US dollar in the medium term. Coupled with negative factors such as the US’s large twin deficits and its own overvaluation, we continue to anticipate a moderate depreciation of the US dollar at some stage. We are thus leaving our six-month (USD1.24) and 12-month (USD1.26) projections for the US dollar against the euro unchanged.
Based on our scenario of a rise in global yields, we continue to favour cyclical currencies (notably the Norwegian krone and the Canadian dollar) over low-yielding currencies, especially the Swiss franc and the Japanese yen, (but to a lesser extent given that currency’s already significant underperformance).