The US dollar is likely to continue in strength until the US Federal Reserve (Fed) pivots and concerns about European energy security and slowdown in Chinese activity ease, says Bank of Singapore’s currency strategist Sim Moh Siong.
In a report dated Aug 26, Sim says that hopes of a “dovish” Fed pivot have waned, with Fed officials alarmed at the prospect of looser financial conditions, continuing to “push back” against the view of a 2023 easing cycle.
“For the US dollar to start weakening, we need the Fed to be more concerned about growth than inflation, and we are far from being there yet,” he writes.
Meanwhile, Europe faces ongoing pressure from surging natural gas and electricity prices driven by fears of Russia weaponising its supply of gas. “This in turn points to headline inflation remaining more elevated in the Euro area and the UK, making Europe an outlier from the disinflation that is likely to unfold elsewhere,” explains Sim.
He says that the recent spike in gas prices has heightened recession risks in the UK, with rising inflation a “powerful squeeze” on household cash flows that will keep pressure on the incoming UK prime minister to deliver more fiscal relief.
With workers pushing for higher wages to cope with rising living costs, Sim believes the Bank of England (BoE) is “under pressure” to tighten faster. “We expect a 50 basis points (bps) September rise and 25bps in November and December. Despite the rise in nominal rates, low real rates continue to highlight doubts over the willingness of the BoE to tighten into a weakening growth backdrop,” he says.
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With stagflationary challenges likely to further weigh on the near-term sterling outlook, Sim’s new forecast looks for the British pound to US dollar to trough at a lower level of 1.14 from 1.17 previously.
He notes that “relief is possible” if the Nord Stream 1 re-opens following the scheduled Aug 31 to Sep 2 maintenance but may “prove fleeting”, while a ceasefire in Ukraine could be a “game changer” for European assets and gas prices but remains an unlikely prospect for the time being.
Nord Stream 1 is one of two offshore natural gas pipelines that run under the Baltic Sea from Russia to Germany.
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Looking across to China, Sim believes that its “bumpy” economic recovery could make the authorities “amenable” to a weaker Chinese yuan to complement the surprise policy rate cut and help ease monetary conditions.
He notes that China remains in “easing mode” and is the “monetary outlier” among the major economies and has raised his US dollar to Chinese yuan forecasts to 7.0 in a year’s time from 6.85 previous.
“The uptick in USDCNY is likely to remain more of a grind and less of the panicky upside momentum we saw in April and May after it broke above 6.40. China’s growth is still seen recovering in 2H2022, albeit more unevenly than some may have hoped for,” says Sim.
He adds that a possible easing of China’s zero-Covid stance later, firmer credit and infrastructure investment should boost economic activity again over the next few quarters.
