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FX: The Dollar Deflates



  • Europe does not look a very attractive investment destination right now meaning that if we are to see a EUR/USD correction this year, it should prove temporary.
  • We could easily see US two-year spreads against EUR and JPY narrowing by another 50bp.
  • We expect pro-cyclical and EM high yield currencies to under-perform the defensive JPY and EUR through March.
  • Our new EUR/USD forecast profile.

By Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE

Given the US dependency on the capital markets for financing, the Fed looks set to be at the forefront of the monetary response to the Covid-19 crisis. The end of US 'exceptionalism' in terms of growth and interest rates means that we should now be looking at a temporary 5-10% correction in the dollar. We revise our 2Q20 EUR/USD forecast up to 1.15

Trouble sticks to the formerly Teflon dollar

2018 to 2019 was characterized by the tax stimulus-powered US economy and President Trump's trade war. The combination of strong domestic US growth set against a slow-down in more open overseas economies created the investment theme of 'US exceptionalism' and triggered a 10% rally in the trade-weighted dollar.

Covid-19, of course, respects no borders and now represents a 'leveling' force in the global economy. US growth and interest rates are therefore converging on the low levels seen overseas and beg the question whether the dollar should still be so strong.

We see (some) parallels here to the 1998 period. Following broad-based dollar strength and US productivity growth from 1995 onwards, US markets received a shock in 1998. The Asian financial crisis spilled over to a Russian sovereign default that year, triggering a collapse in the US hedge fund, LTCM. In response to threats to the financial system, the Fed cut rates 25bp in September, October and November triggering a 10% correction in the dollar.

Arguably, dollar fundamentals were a lot stronger then, given the budget surplus and a slim current account deficit, than they are now and explained the quick recovery which saw USD push back to new highs in 2000. Parallels today also extend to the poor European investment climate that existed in 1999-2001. Europe does not look

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