The pressure from rising US dollar continues to fall

>> Measuring currency risks

Recent weeks have seen a sharp rise in global risk aversion. This has come about as a result of many factors including the continued receding of rate-cut expectations in the US and geopolitical strains, particularly in the Middle East. The customary correlation between rising risk and a rising dollar remains high. But again, as usual, the strains are primarily felt in emerging market currencies, not G10 currencies. Euro/US dollar, for instance, still remains inside the 1.05-1.10 range that has been in place for much of the past sixteen months.

It is possible that ‘risk-off’ sentiment could cause a much more significant rise in the US dollar against other G10 currencies but we feel that the strains will remain concentrated in emerging market currencies. This is in spite of the fact that US dollar strength and Fed policy stability could impinge on the ability of emerging market central banks to ease monetary policy, but won’t stop the likes of the ECB from cutting rates.

Looking ahead, it is more likely that risk aversion will ease in the short term as Middle East fears recede, US GDP growth slows and US inflation angst eases. We may also see better signs that European growth prospects are slowly improving with the release of April PMI data. While we doubt that these factors will send the euro significantly higher against the US dollar, we do think they should help to keep the broad 1.05-1.10 range in place for a while longer.

The IMF warned over the weekend that US dollar strength, borne of robust US growth and high policy rates, is partly related to a fiscal stance that appears untenable over the long haul. One question for the market is whether untenable fiscal policy eventually brings significant pressure to bear on the US dollar even if US interest rates remain relatively high compared to other G10 nations.

While this is certainly a risk, the Standard Bank’s own view is that the US can essentially stretch the elastic on fiscal policy a good deal further before the US dollar becomes imperilled by some sort of buyers’ strike. This being said, there is potentially another threat to the US dollar, which is political interference should former president Donald Trump win a second term in November 2024.

Last week, news leaked out that some advisors to Trump, led by former trade representative Robert Lighthizer, favour a new version of the 1985 Plaza accord, to engineer dollar weakness as major G7 finance minister did all those years ago. While there seems good reason to be sceptical that any such ideas will become a part of government policy should Trump win in November, we do know that the first term saw the former president regularly bemoan US dollar strength. Today, the US dollar is stronger in trade-weighted terms than when Trump was president and the trade deficit is wider. Hence, there’s every reason to believe that there could be the same sort of US dollar-bashing by Trump, should he win in November, even if some sort of coordinated G7 intervention effort to weaken the dollar seems unlikely.

>> Various scenarios for the US dollar

No doubt Japanese officials would like to see a coordinated effort to lower the US dollar, at least against the yen. They presumably pressed home their case for intervention in the yen with other G7 and G20 members at last week’s IMF meetings but, as usually happens, other members seem reticent to express much support. It suggests that, like September/October 2022, any intervention will have to be done by Japan alone, or possibly in conjunction with South Korea, rather than being a full G7 or G20 effort.

In the Standard Bank’s view, with data on speculative positioning in the yen suggesting that the market is very short of the currency, it seems that intervention right now, or very soon, could have a measure of short-term success. But once these excessive short-yen positions are rebalanced, the FX market will still be left with a situation in which US policy rates are 550-bps above those in Japan with a 10-year yield gap of around 380-bps. In other words, the key to a fall in US dollar/yen seems to lie more in Fed easing than BoJ intervention and all the latter can do is to buy time until the Fed cuts.