Can the US dollar keep going up?

The euro/dollar could rise to 1.15 while the dollar/yen could slide to 115.

>> What will drive the US dollar in 2023?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, does not believe this will be the case, but he believes it adds weight to the Standard Bank's prediction that dollar weakness will be modest this year, with periods of strength interspersed.

Mr. Steve Barrow looks for the euro/dollar to rise to 1.15 over the coming year and for the dollar/yen to slide to 115. These forecasts have not changed in light of the 517k surge in US payrolls last Friday. Perhaps that’s not too surprising. It is wrong to upend forecasts based on just one piece of data, whatever the number. The time to really upend forecasts is when major unanticipated events occur, like the global pandemic or the Russia/Ukraine conflict; not when payrolls are above expectations. This being said, there are a number of things to take into account.

The first is that the US labor market is very tight; just as it is in many other countries. This will likely frustrate the Fed’s progress in wringing inflation out of the economy and possibly generate more rate hikes than the market is assuming.

Will a higher peak for the Fed Funds target embolden the dollar sufficiently to test last year’s highs? Mr. Steve Barrow doesn’t think so. For as long as inflationary pressure is easing, he believes that the peak in the fed funds rate won’t be much higher than the market consensus.

"We've factored in a high of 5.5%, which is 50 basis points higher than the median analyst forecast and 50 basis points higher than market pricing.We do not think that the Fed will have to push rates up to 6%, or higher to cope with the tightness of the labor market. Instead, our view is that the Fed will have to take rates only marginally higher than market pricing, but it is likely to hold that rate for longer; at least through the rest of 2023. While this could aid the US dollar, we notice that the market has already pulled back a fair bit from pricing in the start of rate cuts late in the year", said Mr. Steve Barrow.

What’s more, this has always been the Fed’s view anyway, and if the Fed wins this particular battle, it will put a rocket under the US dollar. As long as the market is sure that the Fed is at, or close to, the top of the rate cycle, and can still see the prospect of cuts next year, the US dollar should fall – as long as this policy position does not undermine asset prices, such as stock prices. If risky assets collapse dramatically, the US dollar will undoubtedly continue and accelerate its recent recovery.

In Mr. Steve Barrow’s view, the risk of a significant and prolonged US dollar surge from monetary policy alone comes if the Fed proves to be behind the inflation curve again because labor market pressure, and perhaps other factors, cause a re-acceleration of inflation that threatens multiple rate hikes. "This is not our central view but it is clearly one scenario that could materialize,", said Mr. Steve Barrow.

>> The US dollar’s peak may be behind us

Other scenarios could play out that boost the US dollar as well, such as a surge in global risk aversion brought about by the US debt ceiling dispute or a new intensity in the conflict in Ukraine that draws the west in towards a full-on conflict with Russia.

"While these sorts of tail risks undoubtedly exist, we do not think we should base our forecasts on events that may never happen. In our view, these sorts of risks suggest that currencies such as the euro and yen won’t have free rein to punish the US dollar this year, and our forecasts for US dollar weakness are rather conservative as a result, even if our forecasts do envisage more weakness than the median call of other analysts. We might also expect periods through the year when the US dollar makes a comeback, often because, like now, Fed rate expectations are adjusted. But these bumps in the road should not change the general direction in our view, which is for a weaker dollar in 2023", said Mr. Steve Barrow.