Go Hard or Go Home’ is the message the forex market is sending to central bankers trying to hedge their currencies against an energy price shock. In practice, this means that unless central bankers engage in aggressive monetary tightening to somehow hedge against a 3% Fed policy rate, local currencies will continue to lose ground. ground. Here, policymakers in the Eurozone and especially Japan remain on a very different page than the Fed.
This argues for further dollar strength against the euro and the yen. Moreover, the legacy of the war in Ukraine is stagflationary, especially for Europe. We believe the negative terms of trade shock has damaged the medium-term fair value of the Euro and we can see EUR/USD starting to carve out a range of 1.05 to 1.10 over the course of the summer as the Fed accelerates its policy adjustment. We think it’s too early to ask when the dollar will peak, but in short, we’d prefer dollar strength for most of this year and maybe just a sharp turn lower from the bottom. summer 2023.
Elsewhere, continued strength in commodity prices will continue to support commodity exporters in energy, metals and consumer goods. In general, this is good news for the currencies of US energy exporters and Latin America, while it is negative for Europe and much of Asia. Asia, in particular, will suffer from both larger energy deficits and relatively large food and energy weights in local CPI baskets.
And finally, monetary tightening in CE4 has been impressive. If a path to peace is found in Ukraine, some currencies in the region could still rally. The Polish zloty stands out here, where external transfers could now be converted on the spot market.