22 Jan 2024
…probably supported by both risk aversion and somewhat
…but not every currency is set to weaken against the USD;
the JPY and CAD are likely to stabilise in the weeks ahead
Risk appetite remains the key FX driver, but the near-term path for risk appetite is mostly determined by the outlook for monetary policy, not just in the US, but globally. Current market pricing suggests a ‘co-ordinated easing’ in the US, the Eurozone, and the UK during 2024, with at least 100bp of rate cuts (Chart 1), which is distant from central bank guidance, in terms of both the timing and scale. As a result, if and when markets recognise that the path of global easing is likely to be shallower, this should weigh on risk appetite, thereby supporting the ‘safe haven’ USD, in our view. Paring back rate cut expectations will also provide support for the USD through somewhat higher yields.
Indeed, the likelihood of market repricing of a less aggressive global easing path has seen the USD outperform in the G10 space so far this year (Chart 2). As the gap between market pricing and central bank guidance remains wide, we expect this USD strength to continue over the near term, notably against the EUR and GBP, in addition to the risk-on currencies, like the AUD and NZD. Geopolitical risks will also carry scope to add further momentum to recent market moves. Beyond these global headwinds, the EUR and GBP also faces domestic economic challenges, for which a ‘high for longer’ rate outlook seems unlikely to offer sustained support for these currencies.
However, not every currency is set to weaken against the USD over the near term. For example, the JPY has been the worst-performing G10 currency year-to-date (Chart 2), but we look for a near-term consolidation, followed by a medium-term modest recovery (please refer to “JPY: A modest recovery in 2024” for details). We think that any hint from the Bank of Japan (BoJ) about approaching an end to its ultra-loose monetary policy could provide disproportionate support for the JPY after recent weakness. The CAD may stabilise against the USD, as its weakness so far in 2024 looks overdone, relative to rate differentials and risk appetite.
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