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Wealth Insights | Currencies - Weekly Houseviews and Strategy

DXY driven higher by a hawkish Fed and global vulnerabilities

  • USD:  The broad-based USD Index (DXY) is at near 2Y highs with gains as much due to weakness in other major G10 currencies (EUR, GBP, JPY and CNY) as from a more hawkish repricing of the Fed. For DXY to go even higher would require either – (1) a Fed determined to stamp out US inflation at all costs by following through on the aggressive rate hike/ balance sheet reduction cycle priced by markets – this runs the risk of dislocation within risk asset markets that may encourage safe haven inflows into USD, or (2) further weakness in other G10 FX (EUR, GBP, JPY, CNY) as the terms of trade shock deepens from higher energy costs and weaker growth in China from extended Covid lockdowns. More probable however, is that the Fed signals a willingness to respond to slower growth by moderating its own stance on rates/ balance sheet reduction (possibly by the July meeting) which may then cause US rates to decline more substantially, leading to a weaker DXY.


  • EUR: There appear to be 4 reasons as to why EUR is not strengthening even as markets price higher ECB rates to reign in euro area inflation – (1) at a (expected) 1% peak in the ECB deposit rate (Citi analysts), this would still leave rate differentials favoring USD; (2) a risk premium in EUR from the terms of trade shock from higher energy prices that could deepen and plunge the euro area into recession should there be a ban on Russian gas and oil imports; (3) headwinds from China’s slowdown and a weaker CNY; and (4) French elections – Macron may have won the presidential elections but it is the parliamentary elections in June that hold more sway.  None of these EUR negatives are likely to turn near term with July a possible timeline for any rebound in EUR when the ECB ends its bond purchases, and the Fed possibly moderates its current hawkish stance.


  • GBP: The UK economy follows in the footsteps of the euro area with higher energy costs causing a sizeable terms of trade shock and higher inflation while growth slows. But unlike the ECB, BoE has already commenced its rate tightening cycle to reign in inflation which has led markets to downgrade UK’s growth outlook further via a weaker sterling. Citi analysts still expect the BoE to hike rates by 25bps in May, June and August and then pause, taking the cash rate to 1.5% by year-end. Market pricing through is considerably more hawkish which if the BoE follows through on, could paradoxically result in even more sterling weakness in the short term.     


  • AUD: Market consensus has shifted to May for the timing of the first RBA rate hike as underlying inflation now runs at 3.4%, well above the RBA’s 2-3% tolerance band. With the Australian unemployment rate also expected to ultimately reach 3% in 2023 and wages growth to pick-up (Citi analysts), domestic fundamentals are supportive of a more resilient AUD. That said, vulnerabilities lie with China’s deeper slowdown though this needs to be balanced with the reopening of the Australian economy and expected rapid expansion in services exports. Overall, a brighter domestic and external outlook,  notwithstanding possible headwinds from China’s economic slowdown, creates a more resilient scenario for AUDUSD around the 0.7100-50 level.


  • RMB: PBoC’s recent announcement to cut its FX deposit RRR from 9% to 8% and release some USD10bn in USD supply may help to slow the pace of CNY depreciation but is unlikely to change overall direction. The PBoC is sensitive towards the damage that a rapidly weakening currency can do to sentiment in the SME sector (by raising input costs) and on foreign investment. But PBoC’s easing bias has eroded the “positive carry” on Chinese assets while China’s slowing export momentum coupled with USD strength is likely to continue to drive further CNY deprecation, albeit at a slower pace, potentially targeting the 6.75-80 level.  

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