Global financial markets have started to really feel the squeeze as the Fed pushes ahead with aggressive tightening at a time when events in Europe and China are repricing global growth prospects lower. This is clearly a bullish environment for the dollar – a currency that tends to correlate inversely with the global growth cycle.

In what should be a difficult period for equity and credit markets, we would expect the dollar to stay strong this summer. After all, we are still at the stage of front-loaded Fed tightening. Doubts about the end of globalisation and the need for structurally higher interest rates should also maintain FX volatility at its recently elevated level.

In practice, we think this means that EUR/USD can trade in a pretty wide range for the rest of the year – perhaps 1.00-1.10 with a downside bias over coming months. USD/JPY gains over 130 may well be harder work now, but GBP looks increasingly vulnerable given that investors still price the Bank of England’s Bank Rate well over 2.00% this year.

Read next: FX Daily: Beware of short-lived rallies | ING Economics| FXMAG.COM

Elsewhere in Europe, currencies in the Central and Eastern Europe region remain very volatile and under pressure. The zloty would be our preferred pick on a longer-term view, while the forint remains fragile as twin deficits return to focus. Personnel changes at the Czech National Bank have raised uncertainty around the path of the most favoured currency – the Czech koruna.

Risk aversion and the China slowdown are making life hard for many commodity currencies. Most vulnerable look the likes of the Brazilian real and South African rand – with close links to China. The renminbi itself remains fragile, with USD/CNY risk to 6.80.

Developed markets

EUR/USD

Push Me, Pull Me

Current spot: 1.0522

• The dollar is being pulled higher by the Fed’s decision to take some steam out of the US economy by hitting the monetary brakes hard. 75bp of tightening has been seen so far this year and another 200bp could be seen by December. US 10-year real interest rates have turned positive, in a sustainable way, for the first time since 2019. These could well rise another 75-100bp.
• And the dollar is being pushed higher by weakening growth prospects in Europe and China, where the war and lockdowns have added to supply chain dysfunction and hit growth prospects
• EUR/USD is a pro-cyclical currency, and the cycle doesn’t look good. We cannot rule out EUR/USD at parity this year.

Read next: Rates Spark: Markets are doing central bankers’ job | ING Economics| FXMAG.COM

USD/JPY

Official concern and stretched valuations may help JPY

Current spot: 131.22

• The USD/JPY rally has temporarily stalled around the 130 area. Limiting the move may be two factors: i) Japan’s Ministry of Finance expressed ‘extreme concern’ with the recent spike to 131 – suggesting intervention may not be far off. ii) USD/JPY looks pretty stretched on our medium-term BEER valuation model. We think we’re now in the hard yards of the USD/JPY rally.
• That it is not to say that USD/JPY cannot push further were US Treasury yields to push substantially higher, but the move will be hard work.
• Given a tough risk environment (higher real rates, weaker growth, credit markets unprotected) JPY can outperform on crosses.