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The rally in the US dollar pauses ahead of the Fed

After a series of strong weeks left it at two-decade highs, the US dollar seems set to end this week lower against most major currencies. Despite weaker-than-expected activity data out of the US, UK, and euro-zone this week, cyclically sensitive (i.e., “high-beta”) developed market currencies strengthened the most against the dollar. This coincided with a rally in “risky” assets and a fall in government bond yields; this appears to reflect a view that weakening economic activity will reduce the need for additional monetary tightening. But we doubt slowing economic growth in the US and other major economies – or recessions in the cases of the UK and euro-zone – will bring inflation down to target in the absence of more interest rate hikes by central banks. Indeed, we expect the Fed to deliver another 75bp hike next week and raise rates into 2023. Amid a backdrop of a hawkish Fed and slowing global growth, we think the dollar will resume its broad-based strength before long. Australia Drop-In (15:00 SGT, 27th July): Join our 20-minute briefing on why we think Australian inflation is heading higher than the consensus expects, how the RBA will have to raise rates by more than most appreciate to tame it, and what it all means for Aussie asset prices. Register now

After a series of strong weeks left it at two-decade highs, the US dollar seems set to end this week lower against most major currencies. Despite weaker-than-expected activity data out of the US, UK, and euro-zone this week, cyclically sensitive (i.e., “high-beta”) developed market currencies strengthened the most against the dollar. This coincided with a rally in “risky” assets and a fall in government bond yields; this appears to reflect a view that weakening economic activity will reduce the need for additional monetary tightening. But we doubt slowing economic growth in the US and other major economies – or recessions in the cases of the UK and euro-zone – will bring inflation down to target in the absence of more interest rate hikes by central banks. Indeed, we expect the Fed to deliver another 75bp hike next week and raise rates into 2023. Amid a backdrop of a hawkish Fed and slowing global growth, we think the dollar will resume its broad-based strength before long.

All G10 currencies rose against the greenback this week. (See Chart 1.) Alongside the rebound in global equities and the prices of many commodities, high-beta G10 currencies generally outperformed the euro, franc, and yen. But we suspect the strength of high-beta currencies will prove short-lived given the worsening external environment.

Chart 1: Changes Vs US$ Since 15th July (%)

Sources: Refinitiv, Capital Economics

Meanwhile, the euro’s rebound was less impressive, and it has fallen against the dollar since the ECB’s larger-than-expected 50bp hike and provision of further detail on its “Transmission Protection Instrument”. This may be because the muddled messaging in the subsequent press conference – along with today’s disappointing PMI data – led to a sharp paring back of expectations for ECB rate hikes. While we now forecast a recession in the euro-zone, we still think the ECB will need to raise rates to tame inflation. The upshot is that we are maintaining our year-end forecast for parity with the dollar, although risks continue to be skewed towards more downside.

EM currencies, in general, were broadly unchanged against the US dollar this week. (See Chart 2). Higher commodity prices did little to boost the currencies of commodity exporters such as Brazil and Colombia; the Colombian peso, in particular, may have been weighed by the surprise widening in Colombia’s current account deficit, which is one factor we think will lead to further weakness in the currency.

Chart 2: Changes Vs US$ Since 15th July (%)

Sources: Refinitiv, Capital Economics

Otherwise, in contrast to other LatAm currencies, the Chilean peso extended its sharp rally from last week’s announcement of an FX intervention programme. While this may support the currency in the short-term, we expect slowing global growth and a large current account deficit to remain headwinds to the peso for the remainder of the year.

Finally, currencies in Emerging Europe also staged a bit of a relief rally. But we think that further weakness in the region is likely given growing evidence that the euro-zone is on the brink of recession.

In addition to the Fed, we expect Colombia’s central bank to tighten policy further in its meeting next week. Otherwise, data for Q2 GDP (out of the US and euro-zone) and inflation (out of Australia and the euro-zone) are set to be released.


Key Data and Events

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

25th Jul.

09.00

German Ifo (Jul.)

92.3

90.5

89.5

We think that the German Ifo Business Climate Indicator declined in July. With timelier indicators, such as the ZEW survey and the flash Composite PMI, falling, we suspect the German Ifo dropped to a 25-month low of 89.5 this month. That would be consistent with growth slowing sharply. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

27th Jul.

02.30

Australia CPI (Q2)

+2.1%(+5.1%)

(+6.2%)

+2.0%(+6.5%)

A large quarterly rise in food and fuel prices probably helped to lift annual inflation to a 32-year high of 6.5% last quarter. But we suspect price pressures are broader than these volatile components – we have also pencilled in a healthy 2.0% q/q increase in trimmed mean CPI. We doubt that Q2 will mark the peak in inflation. Instead, we expect inflation to rise further to 8% towards the end of the year. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

27th Jul.

19.00

Fed Interest Rate Announcement

1.50-1.75%

2.25-2.50%

2.25-2.50%

Following the strong inflation print that showed monthly increases in headline and core inflation of 1.3% and 0.7%, respectively, and a healthy increase in non-farm payroll employment in June, there has been some speculation that a supersized 100bp rate hike is a possibility. But with some Fed officials already uncomfortable about the acceleration from 50bp per meeting to 75bp, we think they will opt for a 75bp increase to 2.25-2.50% at this meeting, before slowing the pace of tightening to 50bp at following meetings. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

28th Jul.

13.30

US GDP (Q2)

-1.6%

+0.9%

+1.1%

GDP probably returned to positive growth last quarter following the contraction in Q1, as slower import growth means that net exports probably flipped from a large drag to a boost in Q2. But with consumption growth slowing to only around 1% annualised, we think that overall GDP growth was only 1.1% annualised. We expect the economy to avoid a recession this year, but growth to remain soft as Fed tightening feeds through. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

29th Jul.

10.00

Euro-zone HICP (Jul.)

+0.8%(+8.6%)

(+8.8%)

-0.3%(+8.4%)

We think that headline inflation fell this month due to the drop back in oil prices and, subsequently, lower energy price inflation. But core inflation probably rose due to another pick-up in underlying price pressures and a reversal of some temporary factors that suppressed it in June. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

29th Jul.

10.00

Euro-zone GDP (Q2)

+0.6%(+5.4%)

+0.1%(+3.4%)

+0.2%(+3.4%)

The euro-zone economy probably grew last quarter, but we think that was mainly due to a rebound in the services sector buoyed by re-opening effects offsetting weakness in construction and retail sectors. With business surveys suggesting growth has already slowed sharply, euro-zone growth is unlikely to last into the second half of the year. We think a recession is looming around the corner. (See here.)

Date

BST

Indicator/Event

Previous

Consensus

CE Forecast

29th Jul.

21.00

Colombia Interest Rate Announcement

7.50%

9.00%

9.00%

The central bank upped its pace of tightening to 150bp at its last meeting and made it clear that did not mean subsequent increments would be the same magnitude. We think that it will deliver a 100bp rate hike, But with inflationary climbing to multi-decade high, we think they will opt for another 150bp hike again. (See here.)


Economic Diary & Forecasts

Date

Country

Release/Indicator/Event

BST

Previous*

Median*

CE Forecast*

Mon 25th

       
 

Gha

Interest Rate Announcement

-

19.00%

20.00%

20.00%

 

Sgp

CPI (Jun.)

06.00

(+5.6%)

+0.5%(+6.1%)

(+5.8%)

 

Pol

Unemployment Rate (Jun.)

09.00

5.1%

4.9%

5.0%

Tue 26th

       
 

Kor

GDP (Q2, Adv.)

00.00

+0.6%(+3.0%)

+0.5%(+2.7%)

-

 

Brz

IPCA-15 Inflation (Jul.)

13.00

+0.7%(+12.0%)

+0.1%(+11.4%)

-

 

Hun

Interest Rate Announcement

13.00

9.75%

10.50%

10.75%

Wed 27th

       
 

Ken

Interest Rate Announcement

-

7.50%

7.88%

7.50%

 

Aus

Consumer Prices (Q2, q/q(y/y))

01.30

+2.1%(+5.1%)

(+6.2%)

+2.0%(+6.5%)

 

Aus

Trimmed Mean Prices (Q2, q/q(y/y))

01.30

+1.4%(+3.7%)

+1.5%(+4.7%)

+2.0%(+5.3%)

 

Rus

Industrial Production (Jun.)

17.00

(-1.7%)

(-2.5%)

(-2.3%)

 

Rus

Retail Sales (Jun.)

17.00

(-10.1%)

(-9.3%)

(-9.5%)

 

Rus

Unemployment Rate (Jun.)

17.00

3.9%

4.0%

-

 

US

Fed Policy Announcement

19.00

1.50%-1.75%

2.25%-2.50%

2.25%-2.50%

Thu 28th

       
 

Ang

Interest Rate Announcement

-

20.00%

-

20.00%

 

Aus

Retail Sales (Jun.)

01.30

+0.9%

-

-

 

Nor

Unemployment Rate (LFS) (May)

07.00

3.2%

-

-

 

Swe

GDP (Q2, prov, q/q(y/y))

08.00

-0.8%(+3.1%)

-

+1.1%(+3.4%)

 

Spa

Retail Sales (Jun.)

08.00

-0.8(+1.4%)

-

-

 

EZ

Economic Confidence (Jul.)

10.00

104.0

102.0

99.5

 

Ger

CPI (EU Harm, Jul.)

13.00

-0.1%(+8.2%)

+0.4%(+8.1%)

-

 

Can

GDP by Industry (Monthly, May)

13.30

+0.3%(+5%)

-0.2%(+5.3%)

-

 

US

GDP (Q2 1st Est., q/q ann.)

13.30

-1.6%

0.5%

-

Fri 29th

       
 

Jpn

Tokyo CPI (Jul.)

00.30

(+2.3%)

-

(+2.4%)

 

Jpn

Unemployment Rate (Jun.)

00.30

2.6%

2.5%

2.5%

 

Jpn

Retail Sales (Jun.)

00.50

+0.7%(+3.7%)

+0.3%(+3.0%)

+0.3%(+3.0%)

 

Jpn

Industrial Production (Jun., Prov.)

00.50

-7.5%(-3.1%)

+4.2%(-6.0%)

+6.0%(-6.0%)

 

Jpn

Consumer Confidence (Jul.)

06.00

32.1

-

-

 

Fra

GDP (Q2, prov, q/q(y/y))

06.30

-0.2%(+4.5%)

+0.2%(+3.6%)

-

 

Fra

CPI (EU Harm, Jul.)

07.45

+0.9%(+6.5%)

-

-

 

Cze

GDP (Q2, q/q(y/y), Annualised)

08.00

+0.9%(+4.9%)

-0.1%(+3.4%)

+0.0%(+3.5%)

 

Spa

CPI (EU Harm, Jul.)

08.00

+1.9%(+10.0%)

-

-

 

Pol

CPI (Jul, Provisional)

09.00

+1.5%(+15.5%)

(+15.6%)

+0.7%(+15.9%)

 

Ita

GDP (Q2, q/q(y/y))

09.00

+0.1%(+6.2%)

+0.3%(+3.8%)

-

 

Twn

GDP (Q2, Adv.)

09.00

(+3.1%)

(+3.5%)

-

 

EZ

Flash HICP (Jul.)

10.00

+0.8%(+8.6%)

+8.8%

-

 

Ita

CPI (EU Harm, Jul.)

10.00

+1.2%(+8.5%)

-

-

 

Mex

GDP (Q2, q/q(y/y), Provisional)

12.00

+1.0%(+1.8%)

(+1.1%)

+0.5%(+1.0%)

 

Col

Interest Rate Announcement

19.00

7.50%

9.00%

9.00%

*m/m(y/y) unless otherwise stated; p = provisional


FX Metrics Summary Table

G10

3M Carry1

6-Week Change2 (%)

1-Year Change2 (%)

Implied Volatility3

Risk Reversal4

  

Value

Percentile5

Value

Percentile5

Value

Percentile6

Value

Percentile6

DXY

-

3.9

92

14.6

95

-

-

-

-

EUR

-0.10

-4.4

9

-13.1

7

10.8

78

-2.3

13

JPY

-0.47

-2.5

20

-19.0

3

10.8

75

0.9

40

GBP

1.65

-4.4

7

-12.5

9

10.9

83

-2.6

10

CHF

-0.33

1.3

64

-4.4

16

8.9

62

0.2

33

CAD

2.62

-2.4

17

-2.1

36

7.9

61

-1.5

3

AUD

2.16

-3.7

16

-5.7

29

12.3

80

-2.6

8

NZD

2.97

-3.2

20

-9.8

15

12.0

67

-2.6

7

SEK

1.08

-4.2

14

-14.9

11

13.6

87

-1.7

4

NOK

1.77

-4.5

12

-10.7

14

14.8

92

-2.2

4

EM Asia

CNY

2.04

-1.2

23

-4.1

31

4.7

86

-0.5

21

KRW

1.99

-4.1

8

-12.0

9

10.0

67

-0.2

80

TWD

0.70

-1.2

20

-6.2

7

5.4

64

-0.6

35

INR

6.53

-2.7

12

-6.7

25

5.3

18

-0.7

58

MYR

4.28

-1.3

22

-5.1

20

6.4

43

-0.5

58

IDR

5.55

-3.7

11

-3.6

41

8.3

56

-1.4

46

THB

0.86

-6.0

1

-10.2

5

8.0

99

-0.3

17

SGD

2.41

-0.9

27

-1.9

27

5.7

64

-0.3

62

PHP

5.61

-5.8

1

-10.8

5

-

-

-0.9

23

EMEA

ZAR

6.61

-8.6

7

-12.8

29

15.6

60

-1.9

86

TRY

50.42

-5.5

21

-51.7

3

29.0

96

-11.5

1

RUB

30.58

2.4

78

27.1

99

44.5

97

-11.6

5

ILS

0.07

-2.9

12

-4.9

21

9.0

94

-0.8

34

PLN

7.73

-7.8

5

-16.3

8

15.0

83

-2.4

19

CZK

7.47

-3.6

16

-9.3

14

12.6

99

-2.8

0

HUF

10.52

-6.4

8

-21.7

3

19.3

100

-3.6

2

RON

7.90

-4.2

14

-13.2

17

-

-

-

-

LatAm

BRL

12.92

-10.6

5

-4.5

49

19.8

92

-1.2

88

MXN

9.48

-4.5

12

-2.0

50

11.9

52

-2.5

28

COP

9.30

-14.3

1

-12.3

20

17.8

95

-1.5

28

CLP

9.49

-10.9

1

-18.5

6

22.3

100

-2.3

19

PEN

6.43

-4.4

2

0.5

53

-

-

-

-

Sources: Refinitiv, Bloomberg, CE, as of ~16.00 BST 22nd July 2022; bolded values indicate the top and bottom quintiles of a historical distribution. 1. Implied yield of 3M forwards vs US$; 2. %-changes vs USD, aimed to gauge momentum (6 week) and mean-reversion (1 year); 3. 3M at-the-money option-implied volatility (annualised); 4. Difference between implied volatility of 3M 25-delta put and call options; 5. Since 2000, with the exception of CNY, which is since 2015; 6. Since 2010, with the exception of CNY (since 2015).

Quarterly Forecast Table

G10

Current*

Q3 2022

Q4 2022

Q1 2023

Key Crosses

Current*

Q3 2022

Q4 2022

Q1 2023

EUR/USD

1.02

1.00

1.10

1.15

DXY

106.33

109.43

101.23

101.23

USD/JPY

136

140

130

120

EUR/JPY

139.1

140.0

143.0

143.0

GBP/USD

1.20

1.18

1.25

1.30

EUR/GBP

0.85

0.85

0.88

0.88

USD/CHF

0.96

1.00

0.91

0.87

EUR/CHF

0.98

1.00

1.00

1.00

USD/CAD

1.28

1.35

1.40

1.40

EUR/SEK

10.43

11.00

10.50

10.50

AUD/USD

0.70

0.66

0.64

0.64

EUR/NOK

10.12

11.00

10.75

10.75

NZD/USD

0.63

0.60

0.58

0.58

NOK/SEK

1.03

1.00

0.98

0.98

USD/SEK

10.20

11.00

9.55

8.91

AUD/NZD

1.11

1.10

1.10

1.10

USD/NOK

9.90

11.00

9.77

9.13

AUD/JPY

94.6

92.4

83.2

83.2

EM Asia

USD/CNY

6.75

7.00

7.00

7.00

EUR/CNY

6.90

7.00

7.70

7.70

USD/KRW

1308

1350

1300

1250

CNY/JPY

20.17

20.00

18.57

18.57

USD/TWD

29.9

31.0

29.5

29.0

EUR/KRW

1337

1350

1430

1430

USD/INR

79.8

80.0

78.0

78.0

JPY/KRW

9.61

9.64

10.00

10.00

USD/MYR

4.45

4.50

4.30

4.20

CNY/KRW

194

193

186

186

USD/IDR

15015

15500

16000

16000

 

 

 

 

 

USD/THB

36.6

36.0

34.0

32.0

 

 

 

 

 

USD/SGD

1.39

1.34

1.33

1.31

 

 

 

 

 

USD/PHP

56.1

58.0

60.0

60.0

 

 

 

 

 

EMEA

USD/ZAR

16.81

17.00

17.50

17.50

EUR/ZAR

17.19

17.00

19.25

19.25

USD/TRY

17.73

24.00

24.00

20.00

EUR/TRY

18.13

24.00

26.40

26.40

USD/RUB

57.7

60.0

65.0

70.0

EUR/RUB

59.0

60.0

71.5

71.5

USD/ILS

3.44

3.50

3.30

3.10

EUR/ILS

3.51

3.50

3.63

3.63

USD/PLN

4.63

4.80

4.18

3.91

EUR/PLN

4.74

4.80

4.60

4.60

USD/CZK

24.0

25.5

22.7

21.3

EUR/CZK

24.6

25.5

25.0

25.0

USD/HUF

388

400

355

339

EUR/HUF

397

400

390

390

USD/RON

4.82

5.10

4.68

4.52

EUR/RON

4.93

5.10

5.15

5.15

LatAm

USD/BRL

5.45

5.50

5.75

5.75

 

 

 

 

 

USD/MXN

20.49

21.50

20.50

20.00

 

 

 

 

 

USD/COP

4414

4350

4400

4400

 

 

 

 

 

USD/CLP

924

950

900

875

 

 

 

 

 

USD/PEN

3.91

3.90

3.80

3.80

     

Sources: Refinitiv, CE, *as of ~16.00 BST 22nd July 2022.


Key Forecast Table

DM

2022

2023

2024

EM

2022

2023

2024

DXY

109.43

101.23

96.71

USD/CNY

7.00

7.00

7.00

EUR/USD

1.00

1.10

1.15

USD/INR

80.00

78.00

78.00

USD/JPY

140.0

130.0

120.0

USD/BRL

5.50

5.75

5.75

GBP/USD

1.18

1.25

1.30

USD/MXN

21.50

20.50

20.00

USD/CAD

1.35

1.40

1.40

USD/ZAR

17.00

17.50

17.50

AUD/USD

0.66

0.64

0.64

 

 

 

 

Sources: Refinitiv, CE; all values are year-end forecasts.


Jonathan Petersen, Senior Markets Economist, jonathan.petersen@capitaleconomics.com

Jonathan Petersen Markets Economist
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