In the past
month, the U.S. dollar index (DXY) remained largely stable, exhibiting
fluctuations without a clear directional trend. During October, the dollar struggled
to gain momentum in either direction. Over this period, the dollar strengthened
against the Norwegian krone, Canadian dollar, and Japanese yen but weakened
against the euro and Swiss franc. Its performance against emerging market
currencies was mixed, reflecting the divergent trends in economic activity and
monetary policies seen in currency markets.
However, we
anticipate a more defined upward trajectory for the U.S. dollar in the coming
months and quarters. This projection is based on my belief that the U.S.
economy will experience a delayed recession, and the Federal Reserve (Fed) will
postpone its easing cycle until mid-2024. This monetary policy stance should
favour a stronger dollar in the early part of the next year.
Additionally,
recent geopolitical developments, including conflicts in the Middle East and
the ongoing Russia-Ukraine dispute in Eastern Europe, have created an uncertain
backdrop. In response to these geopolitical tensions, I expect the U.S. dollar
to strengthen as investors seek safe-haven currencies during this period of
heightened instability.
Given the
resilience of the U.S. economy and the Fed’s hawkish-leaning monetary policy,
combined with deteriorating economic conditions in Europe, I anticipate that
the euro and British pound will underperform through the first quarter of 2024.
Furthermore,
due to less favourable economic conditions in Canada, I’ve grown more
pessimistic about the prospects of the Canadian dollar in the next few
quarters.
As we look
ahead to the first quarter of 2024, I expect the Japanese yen to remain on the
defensive, although substantial further depreciation is unlikely due to the
Bank of Japan’s potentially hawkish policy adjustments and Japan’s Ministry of
Finance signalling potential intervention in foreign exchange markets.
I also foresee
upside potential for the U.S. dollar against emerging market currencies.
Central banks in emerging markets have already initiated interest rate cuts,
and the divergence between these actions and the Fed’s hawkish stance should
exert downward pressure on emerging market currencies. Latin American and EMEA
central banks are aggressively cutting interest rates, leading me to predict
that select currencies in these regions will be the most significant
underperformers in the emerging markets.
For instance, I
anticipate that the Chilean peso will underperform due to quick monetary policy
easing and efforts to rebuild central bank FX reserves. I also expect weaker
currencies in Colombia and Brazil as the Colombian central bank is likely to
start an easing cycle, and policymakers in Brazil are expected to continue
cutting interest rates. Among EMEA currencies, I hold a negative outlook for
the Hungarian forint, given policymakers’ more aggressive rate cuts than
financial markets anticipate.
The prevailing
tense geopolitical environment is expected to keep risk sentiment low, leading
to a further depreciation of emerging market currencies, especially high-beta
ones like those in Chile, Colombia, and Hungary.
Looking into
the long term, my view remains that the U.S. dollar will generally depreciate
against both G10 and emerging market currencies. This projection is rooted in
the belief that the U.S. economy will eventually enter a recession, leading to
the Fed’s more aggressive interest rate cuts than what the markets currently
anticipate.
As interest
rate differentials shift against the U.S. dollar, I foresee foreign currencies
strengthening over the second half of the following year and into 2025. While I
expect a near-term decline in some foreign currencies, the Japanese yen is
likely to recover more than most over time. Higher U.S. Treasury yields, a
hawkish Fed, and a more accommodating Bank of Japan have weighed on the
Japanese yen. However, should the Fed reduce policy rates as we anticipate, and
even if the Bank of Japan continues its gradual monetary policy tightening,
yield differentials should favour the Japanese yen in the long term.
As these
dynamics unfold, I expect the USD/JPY
exchange rate to reach JPY146.00 by the end of the following year. Furthermore,
easier Fed monetary policy should alleviate some pressure on select emerging
market currencies in the second half of the following year. Currencies that are
not highly exposed to local political risks, such as those resulting from
elections, and central banks with prudent approaches to monetary easing should
outperform. In this context, certain currencies in emerging Asia can benefit
from their political stability and a sustained “higher for longer”
policy stance.
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This article was written by Luca Santos, Market Analyst at
ACY Securities.