Possible Scenarios for End of This Month

Global Forex Monitor - MAY 2023

In April, the dollar underwent a slower correction compared to March. In response to persistent inflation, the Federal Reserve raised its key rates by 25 basis points to 5.00%-5.25% at the start of May. However, this rate hike did not have a positive impact on the dollar, as the market now perceives it as the final move in this cycle, considering its negative effects on the US banking sector. Following JP Morgan's acquisition of First Republic, PacWest Bancorp experienced significant downward pressure in early May. Consequently, the possibility of a US recession has heightened due to strict bank lending conditions. I anticipate that the Fed will need to reduce rates by 25 basis points in December, while the market has already priced in expectations of a total of 70 basis points in rate cuts by year-end. In this setting, the dollar is likely to continue depreciating throughout the rest of the year. However, in the short term, the dollar could temporarily strengthen if an agreement regarding the US debt ceiling is not reached with the opposition, causing tensions.

In April, the EUR/USD reached 1.10 due to a weakened dollar and a narrowing US-EU interest rate differential. While I believe the Federal Reserve has concluded its cycle of rate hikes, the European Central Bank (ECB) anticipates further increases towards 3.75% or possibly 4.0%, as indicated by some ECB members. This is driven by persistent inflationary pressures and despite tightened lending conditions imposed by European banks. The Euro (EUR) was additionally bolstered by better-than-expected macroeconomic indicators, including industrial production and a decline in the unemployment rate. Over the upcoming months, the combination of a weakened dollar and divergent monetary policies between the Fed and the ECB will continue to support the Euro, with an expected rise to 1.15 by the year-end.

The JPY faced downward pressure, nearing 138, due to the continuation of the Yield Curve Control (YCC) policy under the new Governor Kazuo Ueda of the Bank of Japan (BoJ). However, by the end of the month, a decline in US long-term interest rates enabled the USD/JPY pair to recover to 134. In the short to medium term, I anticipate further appreciation of the JPY against a backdrop of a weakening USD, declining US long-term rates, and potential changes in the BOJ's monetary policy. As a result, I expect the USD/JPY to drop below 130 in the upcoming months.

Among the G10 currencies, the CHF performed the strongest in April, supported by a hawkish speech from the Swiss National Bank (SNB) and ongoing global risks, including the banking crisis and the US debt ceiling. Consequently, the EUR/CHF pair retreated below 0.98. In the short term, I expect the EUR/CHF to remain around 0.98 due to the persistence of global risks.

During April, the GBP demonstrated strong performance compared to most G10 currencies, including the EUR, as it reached 0.87. This was attributed to increased expectations of a rate hike by the Bank of England (BOE) to 4.85% (from the current base rate of 4.25%). These expectations were driven by a rebound in inflation, surpassing 10% in March, and an improvement in economic activity, potentially avoiding a recession. However, due to the contrasting monetary policies with the European Central Bank (ECB), I anticipate the EUR/GBP pair to move towards 0.89 in the upcoming months.

The performance of emerging currencies has been mixed, with many failing to capitalize on the weakened dollar. Asian currencies are still awaiting a clear recovery in the Chinese economy, while Latin American currencies have been impacted by the decline in commodity prices. However, the Indonesian rupiah (IDR) has benefited from high real interest rates, and the Brazilian real (BRL) and Peruvian sol (PEN) have been supported by the hawkish stance of their respective central banks. Additionally, the Hungarian forint (HUF) and Polish zloty (PLN) have continued to thrive due to Europe's positive economic conditions.

The diverging business cycles between China, characterized by reflation, and the United States, marked by a recession, will likely result in a weaker USD/CNY exchange rate, reaching around 6.72 by the end of December.

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