Markets appear happy to live with a large US dollar risk premium, which currently reflects several factors: US portfolio outflows, Trump’s de-dollarisation talk, Fed independence risks, and worries about US deficits and growth. The persistent nature of these risks argues against a substantial unwinding of the risk premium anytime soon, but equally, much of the bad news looks priced into the dollar. For this reason, calls for 1.20 in EUR/USD look premature unless paired with expectations for additional substantial pressure on US Treasuries.
We are not forecasting a dollar capitulation, but instead a new normal of structural USD weakness. In such an environment, local stories can take a more central role, for instance, in determining which currencies stand to benefit most if global instability returns – as a return of the USD’s safe-haven appeal looks unlikely. The European Central Bank is championing the idea of a “global euro moment”, which can keep the euro attractive, but equally faces political obstacles. Looking beyond the short term, we think the yen stands out as a winner in the safe-haven race, while a dovish Swiss National Bank should curb Swiss franc gains.
In the rest of the G10, we expect underperformance for sterling and the Canadian dollar, while antipodeans and Scandies remain in a good position. In emerging markets, higher energy prices should turn central banks hawkish and support stronger FX, net of shifts in global trade tensions.
