Global FX: the US dollar's recent decline is just the beginning
An update on Westpac's medium-term FX forecasts.
Last month we highlighted that participants’ ‘flight to safety’ to the US dollar on concerns over global growth and inflation had weak foundations, with these uncertainties at least as much of a concern for the US as other major nations. Since our last report, data made available for the US has emphasised this point, and the US dollar has quickly fallen back from its recent highs.
Most significant have been the Q2 GDP outcomes for the US and Euro Area. Whereas Q2 US GDP surprised market expectations to the downside, a 0.9% annualised decline reported on the back of Q1’s 1.6% fall, despite the immense headwinds of confidence and declining real incomes, Euro Area growth printed at +0.7% in Q2 following a +0.5% result in Q1, equating to an annualised gain circa 2.5% through the first half of 2022.
Component detail is not provided for Euro Area GDP in the first estimate. But the sectoral breakdown received for the US is troubling. Despite historic strength in the labour market and strong nominal wage growth, consumption growth slowed materially below trend across all three sub-components. Business investment was also weak in the three months to June, while US business surveys continue to signal significant downside risk. The cumulative effect of these trends was a stalling of US domestic demand in Q2.
While weaker domestic demand should improve the US’ trade position, benefitting the dollar, at this time confidence in the growth outlook is much more important. On a two-to-three year view, the US is increasingly at risk of stagnation given weak consumption and investment whereas the Euro Area is showing resilience and must undertake a substantial investment program to insulate itself from energy supply issues and to improve the efficiency of its industry. Their long-term domestic and export growth opportunities depend on this taking place.
So, while the DXY index has swiftly declined from its 2022 high around 109.3 to as low as 105.0 this month (currently 106.6 following Friday’s nonfarm payrolls surprise), we believe this is only the beginning of the US dollar downtrend for the coming 18 months, with DXY seen around 101 at the turn of the year and near 95 by end-2023.
The key bilateral move driving the decline in the DXY index is of course EUR/USD, with Euro seen appreciating from USD1.02 currently to USD1.09 end-2022 and USD1.15 end-2023. A robust gain is also anticipated for the UK’s Sterling, from USD1.22 currently to USD1.26 end-2022 and USD1.34 by end-2023, while modest additional support for the US dollar downtrend should also come from Canada’s dollar, with their economy seemingly more resilient to current headwinds than the US. To our forecast move in USD/CAD from CAD1.29 currently to CAD1.25 end-2023, risks are skewed downward given the anticipated broad-based US dollar decline over the period.
Given the Bank of Japan continue to hold firm to their ultra-accommodative policy stance, the Yen’s abrupt appreciation this month is surprising. However, the move is well founded on relative growth prospects, with GDP growth in Japan positive through 2022-to-date. Further, given their dependence on imported fuel, the nascent decline in global energy prices is aiding their trade position and the Yen.
While we suspect USD/JPY will remain volatile and biased up in the near term, as Japan benefits from Asian growth and the downtrend in energy prices persists, fundamentals will justify the Yen stabilising around JPY132 late-2022. Additional gains are then likely in 2023 as US interest rate expectations reprice, narrowing the differential, and as growth in Japan largely keeps pace with the US. By end-2023, we see USD/JPY at 123.
Asia ex-Japan remains the region of the world most likely to see sustained growth against the US dollar into the medium term. As we continue to highlight, this is principally as a result of their economic development opportunities; though, that the region has largely sustained growth momentum while keeping a lid on inflationary pressures also sets them apart from the US and other developed markets.
While it continues to be held back by COVID-zero concerns and, more recently, bank liquidity and activity risks related to residential construction, China’s economy and hence the Renminbi still hold the greatest long-term promise. We have marked our end-2022 USD/CNY forecast higher to reflect the immediate uncertainty, but continue to see a near 8% gain in Renminbi to USD/CNY6.20 by end-2023 as their quality, income-centric investment agenda bears fruit and the diversity of China’s export markets is increasingly recognised.
A similar gain for India’s Rupee, to USD/INR72 end-2023, and Indonesia’s Rupiah, to IDR14200, is also anticipated as the world re-opens and their respective investment pipelines build.
This analysis initially appeared in Westpac’s August Market Outlook. (PDF 380KB)
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