The dollar has corrected around 3% from its highs seen last month. This has prompted a few questions about whether the dollar has peaked? Many trading partners would hope that to be the case, but the reality is that the Fed is likely to stay on track with its tightening. We think the dollar is more likely to retest its highs than correct much lower.

Driving this view has been consistent rhetoric from the Fed that it will not be blown off target by some softer activity or price data. In fact, it now looks like US activity is accelerating again as lower gasoline prices leave more dollars in the pockets of US consumers. The 2023 US recession narrative looks a tough one to sell near term.

And rising energy prices should continue to drive a wedge between the exporters of North America and the importers of Europe, meaning a much greater conviction of a recession in Europe. The ECB’s second 50bp rate hike on 8 September may well conclude its tightening cycle. Rate spreads and the energy income shock make it a very tough environment for the euro. EUR/USD should therefore drift near parity for much of 2H22.

Elsewhere in Europe, the Swiss franc continues to be guided higher by the Swiss National Bank. Sterling remains vulnerable on recession fears. Beyond some substantial fiscal stimulus, sterling’s best hope is that the Bank of England delivers on most of the aggressive tightening currently priced into markets. Surging gas prices also spell trouble for the CEE4 currencies. The Polish zloty in particular looks unlikely to hold recent gains.

Emerging market currencies have enjoyed a mini-renaissance over the last month. But a difficult external environment makes it hard to sustain those rallies until the dollar turns.

EUR/USD

Late cycle economies will keep the dollar bid

Current spot: 1.0241

• Defining business cycles has been a hazardous job over recent years, but it looks pretty clear that the US is a late-cycle economy with high inflation and low growth. This stage of the cycle is synonymous with inverted yield curves – which we have today. The dollar typically stays bid in this part of the cycle until convictions grow that the Fed will ease, and US 2-year yields start dropping. That is probably a story for 1Q23 and not today.

• We look for another 125bp of Fed hikes this year and just 50bp from the ECB (in Sep.). Risks look skewed to even higher US rates.

• With Europe entering recession on the back of a looming energy crisis this winter, EUR/USD can stay near the lows for 2H22.

USD/JPY

Staying supported

Current spot: 133.44

• USD/JPY has found some good support under 132 and should stay reasonably supported for 2H22. Expect surveys of the Japanese buy-side in September to show greater allocations towards unhedged foreign bond purchases. US Treasury yields pay 250bp+ over JGBs and it is too expensive to hedge those US bond investments – now 3% p.a. through the 3m JPY forwards.

• The Fed Jackson Hole of Aug 25-27th looks a dollar positive event risk. It is far too early for the Fed to signal the all-clear on inflation. The bigger risk is that 2023 Fed easing is priced out.

• Like the euro, the yen is suffering from the negative terms of trade shock. These indices are at the worst levels of the year.

GBP/USD

Slip-sliding away

Current spot: 1.2098

• GBP/USD remains vulnerable on the back of continuing dollar strength and the UK economy trapped by slowing growth and a hawkish Bank of England. The only good news we have seen for sterling recently is that the Bank of Israel plans to double the pound’s weighting in its FX reserve portfolio! • A tricky environment for risk assets in 2H22 – slowing growth, tighter monetary conditions – suggests the growth sensitive pound will struggle. • The only thing helping it should be the BoE remaining hawkish all year – lifting rates 50bp to 2.25% in September – and at least  making sterling an expensive sell. No reprieve for Cable this year.

Disclaimer

This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more