Global recovery to support a US dollar downtrend in 2022/23 as risks clear.
To say that the past month has been tumultuous for global markets is clearly an understatement, with Russia’s invasion of Ukraine and pre-existing concerns around inflation combining to shock expectations for growth and interest rates the world over on a daily basis.
Unsurprisingly, the fears of the market and consequent volatility in risk assets have benefited the US dollar, the DXY index rising from 95.3 as our February edition of Market Outlook went to press to a peak of 99.3 (+4.2%) before easing back to 99.1 currently (+4.0%).
This safe-haven bid for the US dollar, as measured by the DXY index, has been magnified by the disproportionate impact of the Russian invasion of Ukraine on Europe given its reliance on Russian energy imports. Having traded near USD1.15 in early February, EUR/USD subsequently plunged to as low as USD1.08 mid-month (-6.0%), rallying a little to currently be at USD1.095 (-4.8%).
While having a much smaller energy exposure to Russia than Europe, but having benefited materially from a strong inflow of Russian financial capital, the UK’s Sterling has also been shocked lower by the crisis in Ukraine. From recent highs around USD1.36, Sterling has fallen to USD1.30 (-4.4%).
There are essentially two related fears to assess: 1) the new ‘equilibrium’ price of commodities, affecting inflation and interest rates; and 2) the threat of supply shortages, impacting activity and jobs.
While significant for the near-term, higher priced commodities will in time draw a supply response and a drive for efficiency, diminishing the threat to growth. Persistent supply shortages however, whether due to sanctions or retaliation by Russia, would have a much more damaging effect, threatening the viability of European industry and the jobs it creates. At the mid-month lows, arguably the latter was starting to be priced in for both the Euro Area and the UK.
The outlook is clouded by a high degree of uncertainty but, to our mind, there are reasons to believe that the out turn for Europe is unlikely to be as bad as market participants have recently feared. For the immediate near term, it is important to recognise that markets lack both depth and concrete information. So, as has occurred in the past few days, a material portion of risk-off moves can be quickly unwound. More importantly, it must be remembered that economies are dynamic entities. In particular, authorities in the region have capacity to act.
At its simplest, energy infrastructure redevelopment and a push for efficiency across industry will bolster activity and jobs, particularly if the coordinated response of European officials continues. Notably for markets, this development brings the promise not only of coming relief, but a more competitive and profitable production base in the long run. While it cannot be relied upon, the immense pressure that Russia’s economy is under is also likely to see the Kremlin yield, potentially providing further benefit to Europe in the form of lower input prices and restored supply.
While recognising that further near-term volatility is likely and an escalation of the conflict a significant risk, we believe the best baseline view to hold for currency markets is a slow appreciation of Euro and Sterling against the US dollar over the forecast period. Respectively we anticipate gains from around USD1.10 and USD1.30 currently to USD1.15 and USD1.37 in late-2023 (circa +5.0%).
These moves are the primary drivers behind our DXY forecast for a 3.5% fall from 99.1 currently to 95.6, partly offset by small gains for the US dollar against Japan’s Yen, USD/JPY rising to JPY119 over the forecast period.
While the Yen is expected to continue to lose ground, we anticipate robust FX gains for the rest of the region. China’s Renminbi has outperformed recently, USD/RMB having fallen from RMB6.37 at the end of January to below RMB6.32 before another round of COVID-19 fears reversed the move. We see further gains in the period ahead once these virus fears subside, forecasting USD/RMB to fall to RMB6.10 by end-2023 (-4.3%). The momentum evident in China’s economy at the turn of the year and its plans for enduring economic development signal upside risks for the Renminbi versus the US dollar, although it must be recognised for the near term that we are nearing historic lows for the currency pair which may prove a tough technical level to break.
Albeit from a weaker starting point, a similar gain is anticipated for Singapore’s dollar against the US, from SGD1.37 to SGD1.32 (-3.6%), and in currencies of the countries nearby. India has the capacity to outperform this regional trend, particularly after recently being hit by risk aversion. However, to our bullish forecast of a fall in USD/INR to around 72.0 (-6.0%), there is considerable risk, particularly if geopolitical tensions continue to exert pressure on global financial markets.
