The USD erased its gains since mid-July in late 2023 on speculations that the US Fed might pivot to policy easing in 2024. With our forecasts for below-trend global growth in 2024, recent market trends seem at risk of reversal over coming months. Tactically, we have now turned negative on the CHF.
In the near term, the bearish dollar story appears a bit ahead of itself. The Goldilocks scenario of lower yields alongside resilient growth is already well priced. Any modestly positive or negative US economic surprise is likely to trigger a temporary US dollar rebound.
The market is pricing almost seven US Federal Reserve (Fed) rate cuts by January 2025, along with double-digit US corporate earnings growth within the S&P 500 index. If the US labor markets and business conditions remain strong, as implied by high corporate earnings expectations and tight credit spreads, there is room for some of those rate cuts to be priced out over the next couple of months, benefitting the dollar.
The US remains one of the highest-yielding and highest-growing economies in the G10. A more substantial slowing of economic activity would better justify more than seven rate cuts, but a slower economy would likely threaten the earnings outlook and lead to equity market volatility and a safe-haven bid for the US dollar, driving the dollar higher.
Given the struggles in commodity markets and G10 growth outside the US, we see downside risks for higher-beta currencies such as the Australian, New Zealand, and Canadian dollars, as well as the Scandinavian currencies.
Figure 2: December 2023 Directional Outlook
However, both the Norwegian krone and Swedish krona are extremely cheap from a longer-term perspective. While the yen may struggle to extend its gains against the US dollar in the near term, we remain broadly positive relative to the G10 average, as global disinflation and weaker growth contribute to lower yields, and add uncertainty to the medium-term equity outlook.
We have long held the view that the US dollar is likely to fall at least 10%–15% over the coming years, but is currently in a noisy transition period from a bull to a bear market, a protracted range-trading environment. We strongly recommend investors with a horizon of more than two years to position for a lower US dollar.
However, a sustained US dollar bear market does not appear imminent. The world is in a fragile place, while the US grows well above trend, offers high yields, and the US dollar tends to provide a good hedge for risky assets if we slide into recession. Consequently, we believe that any modestly positive or negative US economic surprise is likely to trigger a US dollar rebound into Q1 2024.
The Canadian dollar remains one of the lowest-ranked currencies by our short- and medium-term models. The rapid deceleration in growth, coupled with weak commodity prices, suggests potential further weakness for the Canadian dollar.
Resilient inflation and labor markets are likely to give way to the weaker economic conditions over the next several months, potentially leading to an earlier or more rapid monetary easing cycle in Canada relative to the US and other countries. This risk appears to be underappreciated in the current market pricing and suggests scope for Canadian dollar weakness.
In the longer term, we think Canadian growth will remain competitive, and the Canadian dollar looks cheap in our estimates of fair value relative to the euro, the Swiss franc and the US dollar, creating room for substantial upside.
We maintain a neutral view on the euro against the G10 average and a negative view against the US dollar and the yen. While the European Central Bank (ECB) may not have discussed rate cuts at its December meeting, rapid disinflation and near recessionary conditions suggest a strong case for rate cuts over the course of 2024. This is a challenging environment for the euro as the combination of high European Union (EU) recession risk and softening ECB policy outlook is likely to weigh on the currency.
However, heightened global uncertainty and equity volatility over the next few months may help support the euro against higher-beta currencies, as will the ongoing weakness in commodity markets.
Our factor models remain neutral to slightly negative on the pound versus the G10 average, but are quite negative against the yen and US dollar. We see risks to the pound skewed lower as the economy stagnates. Inflation and wages are finally accelerating lower; and the UK economy faces the constraints of high fiscal and current account deficits.
However, we see similar average risks across most G10 economies and currencies, resulting in a relatively neutral tactical outlook for the pound. In addition, the UK’s economic stagnation is proving to be surprisingly stable, meaning the risk of falling off a cliff into recession has proven limited. We can see this via the rebound of services and composite Purchase Managers’ Index back into expansionary territory and relatively stable home prices, while the recent sharp drop in longer-term yields helps alleviate some pressure from mortgage refinancing.
In contrast, our long-run valuation model has a more positive pound outlook, as the currency screens as cheap to fair value. But we expect sticky inflation and chronically weak potential growth post Brexit to weigh on fair value, somewhat limiting the potential pound upside over the next several years.
Our models have maintained a positive view on the yen relative to the G10 and a negative view versus the US dollar, given high US interest rates and strong relative growth. The first quarter may be quite volatile, but we see risks skewed toward a broad yen recovery in 2024 as yields peak and turn lower, while below-trend global growth creates an increasingly fragile environment for risky assets.
The increased likelihood that the Bank of Japan (BoJ) may exit negative interest rate policy by mid-year is also supportive, though the magnitude of potential BoJ rate increases is tiny compared to the scope for rate cuts across the rest of the G10. We believe foreign interest rate policy will remain the bigger driver of the yen. The clear shift in global monetary policy from tightening to a broad pause with an eye to 2024 easing creates a persistent positive backdrop for the yen over the next 6–12 months.
We are negative on the franc over both the tactical and strategic horizons. It is the most expensive G10 currency per our estimates of long-run fair value; growth data remains soft; inflation stable within target ranges; and, aside from the yen, the franc has the lowest yields in the G10.
The monetary policy outlook is also likely to continue to shift in the first quarter. The Swiss National Bank’s (SNB) statement no longer expresses a bias toward franc-supportive intervention, suggesting that it views the franc at elevated levels. This was before the sharp appreciation at year-end brought the real trade-weighted franc to more than a 30-year highs. If this strength continues into the first quarter, it could easily induce the SNB to intervene to weaken the franc. Such a shift is likely to provide a catalyst for the highly overvalued franc to begin a reversion back down toward our estimate of its longer-term fair value, although we also likely need to see stabilization and early signs of recovery in the EU economy.
The more vigilant central bank and reduced krone sales are clear positives. However, our short- and medium-term models remain negative on the krone due to weak oil prices and disappointing growth data. Even the relative tightening of the monetary policy outlook has had limited impact beyond the near term. The current market pricing of future interest rates anticipates lower inflation, and an eventual and significant easing of monetary policy over the next year.
Our short-term value model suggests that the recent krone strength has substantially outpaced its fundamentals. Going forward, we also think it is prudent to be cautious on global risk sentiment and its impact on the krone. In the long term, the outlook is positive. The krone is historically cheap relative to our estimates of fair value and is supported by steady potential growth.
Our short-term value model is strongly negative on the currency, as it estimates that the recent strength in the krona is not justified by economic data. The ongoing Riksbank reserves hedging program and potential for further near-term resilience in equity market sentiment probably limits downside over the near term, but those positive factors appear limited going forward. The krona buying program is likely to end in January–February and the potential for a period of consolidation and higher equity market volatility appears likely in Q1 following the amazing gains since October.
Eventually, though maybe not in the next several months, Swedish and global inflation will be under control and the economy will begin a more durable recovery. Once that happens, the historically cheap krona has substantial room to enjoy a broad-based appreciation back toward its long-run fair value on a sustained basis.
Our models continue to see medium-term risks tilted to the downside for the Australian dollar on weak commodity prices, sluggish economic growth, underperformance of Australian equity markets, and the overall fragility of the global growth outlook heading into 2024.
On a more positive note, we do not expect the Reserve Bank of Australia to ease monetary policy as rapidly as in the EU or North America in 2024. And given the Australian dollar’s subdued performance, it does not appear as overbought as other commodity-sensitive currencies such as the Norwegian krone. Additionally, we anticipate a small uptick for the Australian dollar on improvement in Chinese growth following the recent fiscal and monetary stimulus, helping the currency limit downside.
We are increasingly pessimistic on the New Zealand dollar over the near term. Slowing growth, poor commodity prices, and the weak external balance—the current account is –7.5% of GDP—more than offset any benefit of high yields.
Our short-term value model suggests that the dollar is significantly overbought. Unlike the krone, the New Zealand dollar’s overbought condition is not due to a strong rally in the currency. Rather, our model suggests that the New Zealand dollar should have fallen in response to weaker fundamental conditions, but has not.
In the longer term, our New Zealand dollar outlook is mixed. Our estimates of long-run fair value suggest that it is cheap against the US dollar and the Swiss franc and has ample room to appreciate, but is expensive against the yen and the Scandinavian currencies.
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