Most top-tier bank analysts are dialling back their US Dollar forecasts on the following premises.
Over the last couple of months, the risk of a much higher peak has diminished. Most importantly, a couple of more relaxed inflation prints have reinforced a slower pace of Fed hikes, which tends to ease financial conditions and weaken the Dollar.
Last week, the Fed did not materially change its strategy to push back on recent FCI easing. Instead, the FOMC maintained that it is likely approaching the end of its hiking cycle, albeit to a somewhat higher peak, with policy already in restrictive territory. Goldman Sachs
But, in the space of a few hours last week, the world's two biggest central banks – the Fed and ECB - provided a clear message: financial conditions must stay tight.
Within that context, notably, both the ECB and Fed are now explicitly shifting focus from CPI to the labour market, implying that supply-side improvements in the goods side are not enough to declare the mission accomplished. The overall message for 2023 seems clear: central banks will push back on higher risky assets until the labour market starts to turn.
What does that mean for the EURUSD?
The ECB delivered the clearest hawkish signal last week. In my view, the strongest signal came from the Governing Council's guidance that rates still need to "rise significantly at a steady pace," which President Lagarde suggested means a series of 50bp hikes. That is quite a different signal than other central banks who believe the hiking cycle is closer to the end.
While we wait for a USD rival to run with the currency baton, I think the EUR is set to significantly outperform currencies where central banks are either unwilling or unable to sound as hawkish (GBP, SEK, AUD, CAD).
And while I'm very comfortable with the idea that the US dollar peak is in the cards primarily due to the downswing in US inflation and China's new-found "living with Covid" approach. For a significant broad dollar downtrend, we need an inflection point in the growth cycle where global growth picks up steam.
With the USD as a high-yielder, it remains a beneficiary of tight financial conditions and late-cycle growth dynamics. So ideally, we need the Fed to declare "mission accomplished" before turning unbridled US dollar bears.
Aisa FX
Since the last FOMC meeting in early November, the Dollar has depreciated significantly versus most Asia FX currencies for a few reasons. But first and foremost, this has been driven by China's ongoing reopening, which is progressing at a faster pace than most had anticipated: NJA low-yielders, in particular, have outperformed their typical sensitivities to global market factors or their G9 FX peers, given the crucial impacts of Chinese reopening on regional economies, I would not fade these moves instead I would buy on dips.
Trade Idea
Recent news suggesting an earlier-than-expected reopening in China has led both AUD and NZD to appreciate quickly, with NZD also benefiting from a decline in the US 10-year yield and a more hawkish RBNZ.
AUD should be a more significant beneficiary than NZD from terms of trade perspective on a resumption of Chinese demand, but we would need to see more hawks at the RBA as the policy remains a crucial difference in the AUD/NZD trade.
Economic data in Australia have surprised the upside, including this week's employment report. As a result, the market may start to price at a higher terminal rate pricing in Australia, which could strengthen the currency.
Comments