Is it time to limit short US dollar positions?

The dollar rally in the second half of the year came to an end in November as the Federal Open Market Committee (FOMC) communicated it was now “on hold” as inflation and labor market data in the US cooled by more than expected.

Fed rate cut expectations

Rising expectations of a Federal Reserve rate cut in the first half of 2024 is putting pressure on the US dollar, with the pound, euro, Swiss franc, yuan and Australian dollar all marking fresh multi-month highs against the USD.

Markets have now priced in a 43% probability of a cut in March and a more than 50% probability of a further move lower in May*.

Base case for the dollar

Like the Long-Term Capital Market Assumptions (LTCMAs), our base case remains that the dollar should ultimately unwind the overvaluation that built up in 2022 over the medium term. However, we remain neutral on the dollar against most currencies until we see clearer signs of US-Reset of World growth and rate differentials re-converging. We are optimistic that occurs over the next year, but have it pencilled in for the second half of 2024.

What we’re watching: U.S. growth momentum, ROW (Europe & China) economic surprise indices.

Our view: DXY: 105 (103-107) by mid-2024

100 (98-102) by year-end 2024

Will the ECB cut rates? What will it mean for the euro?

Europe remains the primary laggard in the global economy. We see a high chance the European Central Bank (ECB) atypically leads the Federal Reserve in terms of rate cuts this cycle. Last month, we downgraded our outlook for euro dollar (EURUSD) to reflect a weaker European growth backdrop and elevated geopolitical tensions which pose an outsized risk to the region. Our base case expects EURUSD to be rangebound at low levels in the near-term. Current fair value estimates based on interest rate and growth differentials center around $1.05.

We continue to pencil in some slight upside in 2024. The Euro should benefit over time from global investors closing underweights to European fixed income now that negative rates are a thing of the past and the current degree of US cyclical outperformance should ultimately fade. However, the path to that point will likely be choppy, especially if US growth continues to prove resilient for an extended period of time. Our preferred way to position for a European growth slowdown is via short euro Swiss franc (EURCHF).

What we’re watching: Eurozone vs. U.S. growth momentum, fixed income flows.

Our view: 1.06 (1.04 - 1.08) by mid-2024

1.12 (1.10-1.124) by year-end 2024

All outlook estimates represent the midpoint of our range. GDP and inflation numbers have a +/-10bps range, rates have a +/-25bps range, and all other outlooks are within the range that is provided. Estimates, forecasts and comparisons are for illustrative purposes and are as of the dates stated in the material. Please refer to “Definition of Indices and Terms” for important information. Past performance is no guarantee of future results and investors may get back less than the amount invested. It is not possible to invest directly in an index.

* CME FedWatch as of November 29 2023

All outlook estimates represent the midpoint of our range. GDP and inflation numbers have a +/-10bps range, rates have a +/-25bps range, and all other outlooks are within the range that is provided. Estimates, forecasts and comparisons are for illustrative purposes and are as of the dates stated in the material. Please refer to “Definition of Indices and Terms” for important information. Past performance is no guarantee of future results and investors may get back less than the amount invested. It is not possible to invest directly in an index.