The DXY dollar index has declined about 1.7% since the start of June, with its fall accelerating since weaker employment data last week rekindled hopes that the Federal Reserve might feel able to end its rate-hiking cycle soon.
The move has reversed much of the dollar’s rally in May, which was spurred by more positive economic data.
While the dollar index has been relatively resilient in the first half of 2023, falling only around 2%, it is still roughly 10% down from a 20-year high struck in September. We expect the downward trend in the dollar to continue as the US interest rate premium over peers continues to shrink.
Rhetoric from top European Central Bank officials has become more hawkish. Most recently, Isabel Schnabel of the ECB’s Executive Board delivered a speech on “the risks of stubborn inflation,” in which she said they should “err on the side of doing too much rather than too little.” This added to confidence in markets that the ECB will raise rates in both July and September, taking the deposit rate to 4%. Other top policymakers have sounded less hawkish—while not ruling out raising rates in September. Peter Kazimir, Governor of the National Bank of Slovakia, said the September meeting was “open, and it remains to be seen what will be done.”
Yields in the UK have been rising swiftly ahead of the Bank of England’s policy meeting this Thursday. The yield on 2-year gilts rose 14 basis points to 5.06% on Monday, the highest level since 2008. They are now about 100 basis points higher since 24 May, when data pointed to unexpectedly high inflation—including the highest core rate in 31 years. Investors have also been reacting to strong jobs data last week. For the first time since the turmoil surrounding the mini budget of former Prime Minister Liz Truss, overnight index swaps were implying a 6% base rate. The Bank of England is expected to raise the base rate by 25bps to 4.75%.
The global trend toward tighter policy is also intact, as underlined by recent comments from a top Reserve Bank of Australia official. Deputy Governor Michelle Bullock on Tuesday characterized the domestic labor market as tight and said containing inflation would mean higher unemployment. Minutes of the central bank’s 4 June meeting, at which the RBA raised rates by 25bps, suggest officials remained concerned that inflation would become embedded and the risks to inflation had shifted to the upside. Additionally, the improving economic backdrop suggests the Bank of Japan is likely to tighten its very loose monetary policy in the second half of 2023. In Switzerland, we expect the Swiss National Bank to remain hawkish to keep price pressures contained and the franc stable in real terms.
Against this backdrop, we expect the US currency to trend lower in the months ahead. We recommend investors with the Japanese yen, euro, British pound, or Swiss franc as their home currency to strengthen their home bias. We also expect gold to reach new all-time highs. Investors can consider various strategies to enhance yield by utilizing volatility in the options market. Volatility-selling strategies based on the pound, the Australian dollar, and the yen all look attractive to us in the current environment.
Main contributors – Solita Marcelli, Mark Haefele, Christopher Swann, Vincent Heaney, Jon Gordon