The US dollar’s surge looks unlikely to endure

The resurgence of the U.S. currency is also close to pushing the euro to parity – at 1.012 euros on Friday – with investors fearing the European Central Bank’s efforts to rein in inflation could be hampered by energy shortages and the widening of peripheral bond spreads.

The U.S. dollar also forced the pound back below levels seen during the pandemic low and in the aftermath of the 2016 Brexit vote.

In the current climate of risk aversion in the markets, the recovery of the US dollar should continue in the short term. But in our view, this strength is unlikely to persist over the long term.

Further US dollar strength will likely be limited by slowing US economic growth and market perceptions that the Federal Reserve will start cutting rates again in 2023. Recent data has been mixed. But there is evidence that the US economy is starting to cool. The number of Americans submitting new claims for unemployment benefits rose last week, with layoffs hitting a 16-month high in June. This coincided with the release of the ISM services survey earlier this week, in which the employment component fell to a two-year low.

Investors will look for further evidence of moderating labor market pressures from today’s non-farm payrolls release. Signs of weaker growth have led investors to revise expectations of Fed tightening in 2022 down from around 355 basis points in mid-June to 330 currently. Futures now suggest the Fed will need to start cutting rates again around May next year to support growth. This is a less favorable context for the American currency in the medium and long term.

The Swiss franc now looks more attractive than the US dollar as a safe haven, especially given the central bank’s willingness to allow currency appreciation to curb inflation. The surprise 50 basis point rate hike by the Swiss National Bank (SNB) in June was seen as an early first step in tightening, especially as inflation at the time was just under 3%. Even with inflation at 3.4% in June, the highest rate since 1993, price pressures are still subdued compared to other parts of Europe and the United States. In the meantime, the SNB has shown itself to be more willing to allow the franc to appreciate in order to contain inflation. This combination helps explain why the franc is only slightly lower than the US dollar and is now worth more than the euro for the first time since a brief spike in 2015.

Commodity currencies are also expected to appreciate, notably the Canadian and Australian dollars, as the recent crisis of commodity weakness reverses. The price of Brent came under pressure this week, falling from above $114 a barrel on Tuesday to $104 a barrel on Friday, reflecting concerns about slowing global growth. We expect that move to reverse as OPEC+ nations struggle to meet production quotas and future pandemic restrictions in China are less stringent than expected.

In addition, recent data has highlighted the strength of the Canadian and Australian economies. In Australia, domestic credit, housing starts and retail sales have all surprised positively lately. Canada’s GDP grew at a solid 3.1% annualized pace in the first quarter, while retail sales beat expectations in May. As a result, we expect central banks in both countries to remain on a tightening trajectory, supporting their respective currencies, as well as our expectation of a further rally in commodities.

We therefore advise investors not to position themselves in favor of a continuation of the rally of the American dollar. Instead, our preferred safe haven currency is the Swiss franc. We also favor commodity currencies, which we expect to benefit from the rebound in commodity prices from the recent decline.

Main contributors – Mark Haefele, Thomas Flury, Otto Bismarck Piasecki, Christopher Swann, Jon Gordon, Clémence Dumoncel

The content is a product of the Chief Investment Office (CIO).

Read the original report – US dollar surge not likely to last, July 8, 2022.

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