FX markets waiting for clear air to position for growth
Recent trading activity suggests participants are positioning to pursue opportunities outside the US dollar.
When we released the last edition of Market Outlook in mid-April, the US dollar DXY index sat at 98.2. Today it is a touch lower at 98.0 and, in the intervening period, the index traded a 1-point range – the definition of marking time. Participants have not been short of headlines, rumours and data to assess. Instead, the sum of available information has been heightened uncertainty over the immediate and medium-term outlook, leading participants to refrain from trading.
Assessing the market moves that have occurred and the information which inspired them, there is evidence to suggest many participants are waiting for the current crisis to end so they can pursue opportunities outside the US dollar. Supporting this view, risk-off moments have resulted in very limited upside for the US dollar – Project Freedom’s announcement and the ensuing skirmishes between Iran and the US in the Strait of Hormuz are a good example of this. Meanwhile, signs of stability and reports of dialogue have buoyed equities globally and seen pro-risk currencies test the upper end of recent ranges against the US dollar – the Australian dollar is a prime example, having traded through USD0.72 in recent days.
Of the DXY constituents, Japan’s yen has led the way. Authorities’ concern over the cross breaking above JPY160 was followed by multiple rounds of intervention from late-April, a decision not taken since 2024; along with global developments, these actions have resulted in a sustained recovery from an intra-day high of JPY160.7 to near JPY157 (a near 2.5% appreciation for the yen).
An immense degree of pressure remains on the yen – against the US dollar, it is currently more than 40% below the average of 2018 and 2019, prior to the pandemic. That said, with the Bank of Japan expected to raise rates in June while the FOMC holds, and if concerns over military conflict in the Middle East and energy supply begin to subside, a sustained appreciation for the yen versus the US dollar and, to a lesser degree, other major trading partners is probable.
Based on our expectation for a protracted recovery in energy markets, we look for the yen to slowly appreciate through 2026-2028, USD/JPY declining from JPY157 today to JPY150 at mid-2027 and JPY142 come mid-2028. A stronger appreciation is possible if Japanese growth outperforms and/or the Bank of Japan takes a more hawkish stance. However, the reality is that Japan is more exposed to imported energy inflation, affecting real incomes and spending, and arguably lags major neighbours with respect to technological progress and efficiency – China, Taiwan and South Korea are all in a stronger position.
Moreover, investors are increasingly recognising the growth potential of south-east Asia, in part due to foreign investment by the above north-Asian nations. Investment flows should follow the activity undertaken more than the country of residence of the investor, and so support for Asia FX against the US dollar is likely to spread across the region.
Of the countries mentioned, we look for China’s Renminbi and Taiwan’s dollar to show the most persistent strength. USD/CNY is expected to continue trading down from CNY6.80 to CNY6.50 in mid-2027, then CNY6.35 by mid-2028. USD/TWD meanwhile is forecast to fall from TWD31.4 to TWD29.2 in a year’s time, and TWD28.2 come mid-2028. Opportunity is also apparent for South Korea’s won and Singapore’s dollar, although at SGD1.27 the latter cross is already at the lower end of the historic range versus the US dollar.
For the rest of Asia, economic and industrial development is expected to win out in time; however, the shadow cast over energy security by recent developments in the Middle East and the impact of higher prices on household and businesses’ finances will likely see investors remain focused on risks to the outlook for the foreseeable future. Countries such as the Philippines and Indonesia are most exposed, while Vietnam is arguably best positioned to receive support from China given its importance to China’s manufacturing and logistics networks, and as Chinese firms are already working at scale on infrastructure projects across Vietnam, with more to come.
Coming back to Europe and the UK, the state of play against the US dollar has changed little over the past month. Our views on the region’s outlook are also largely unrevised. As discussed on page 22 of our May Market Outlook, recent communications from the ECB and Bank of England point to a modest policy tightening in coming months to guard against inflation risks. However, both central banks are also keeping a close eye on downside risks for activity – a greater risk for the UK given labour market slack was already building ahead of the current conflict.
Participants are likely to take confidence from policy makers direction and will also expect that, as the drag on discretionary incomes lifts, activity growth in each jurisdiction should strengthen. Hence, we look for EUR/USD to appreciate from USD1.18 today to USD1.21 in mid-2027 and USD1.22 come mid-2028. Sterling is seen appreciating from USD1.36 to USD1.39, then USD1.41 over the two-year forecast horizon.
In closing, it is worth noting that, at least initially, euro, sterling and yen are most likely to benefit if downside risks for the US crystalise. In time though, investors are likely to see greater opportunity in Asia, and capital will be repositioned to take advantage.
This analysis initially appeared in Westpac Economics’ May Market Outlook (PDF 3MB).
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