Credit Agricole with what strikes me as a good guide to the year ahead for DXY.
The Fed tightening cycle was the main driver of FX markets in Q123 as investors tried to position for peak Fed hawkishness amid conflicting signals ranging from strong US data to banking sector turmoil, more recently. As a result, at the end of Q1, the US rates markets have gone back to their views from early 2023 of a Fed rate peak of c.4.9% around mid-year and aggressive rate cuts into H223. The USD was on a rollercoaster ride in recent months as a result, trading close to its multimonth lows in the final stages of Q123.
Looking ahead into Q223, the Fed outlook will remain a key USD driver. We expect the FOMC to deliver one final hike in May before pausing. Our historic analysis suggests that the USD tended to appreciate by c.2% on average in the three months leading to the final Fed rate hike before losing some ground once the Fed paused but mainly vs the JPY, CHF and EUR. This suggests that while the USD could recoup some ground in Q223 it could remain a sell-on-rallies vs other safe-haven currencies.
Looking beyond Q223, we think that two additional FX drivers will start dominating FX price action. The first is a US recession that we expect in H223. Our analysis of the last six US recessions since 1980 suggests that the USD gained ground at the start of the recession mainly vs riskcorrelated currencies but ended up depreciating in the subsequent six months, with its losses most pronounced vs the JPY, CHF and EUR.
Another important USD driver in Q323 will be the looming US debt ceiling. The Congressional Budget Office recently signalled that the socalled ‘date-x’ when the US government will run out of funds to meet its financial obligations would come around July-August. Our historic analysis suggests that the political uncertainty that usually preceded any debt ceiling resolution has been negative for both the USD and the riskcorrelated currencies while the JPY, CHF and gold benefited.
The USD underperformance was more pronounced when government shutdowns preceded a debt ceiling resolution. In contrast, however, when the debt-ceiling debacle took place during a recession – as was the case in 2008 and 2009 – the USD rallied broadly. Our analysis further suggests that the USD was able to more than recoup its losses once the debt ceiling was resolved. That said, the JPY and gold were able to hold their ground vs the USD.
The above results underpin our forecast profile for the USD according to which the currency could follow a volatile path but should ultimately remain under pressure for the remainder of 2023. In that, any USD underperformance should be more pronounced vs safe-havens like the JPY, CHF and EUR as well as gold while the USD could hold its ground better vs risk-correlated currencies against the backdrop of heightened market uncertainty surrounding the peak of the Fed tightening cycle, a US recession and a debt ceiling debacle.
That amounts to a buy the dips argument for gold.