The U.S. dollar will be on the "defensive" against major peer currencies this year as the U.S. interest rate gap with others narrows, per a new Reuters poll.
Most of the 90 forex strategists participating in the poll predicted that the dollar would lose ground to other major currencies in a year. The strategists highlighted the critical role of interest rates in currency movement.
Dollar's crown to slip as peers catch up in rates race: Reuters poll https://t.co/FJlXgzGVap pic.twitter.com/pbaNp4IGNx
— Reuters (@Reuters) April 5, 2023
Rate differentials will be the main driver of the dollar's movement in the coming months. The strategists explained that high interest rates typically drove the market to invest in safer asset categories, like the U.S. dollar and bonds.
Lee Hardman, a currency economist at financial group MUFG, predicted that the dollar would continue to weaken over the following three to six months.
"I guess recent developments have been the loss of confidence in the U.S. regional banks, which has increased downside risks to the dollar," Hardman said.
Analysts explained that the greenback began 2023 on a weak footing but eventually rose by three percent in February on expectations of further interest rate hikes by the U.S. Federal Reserve.
In March, however, the implosion of two U.S. regional lenders created widespread banking turmoil, pushing the Fed to reconsider its tight monetary policy that had partially contributed to the crisis.
Although fears linked to the crisis have subsided, most investors still expect the central bank to make a policy pivot soon. The new expectations of the Fed's future monetary policy caused the dollar to retreat and gave back most of its February gains last month.
"So we kind of agree with the dovish repricing that's taking place in the U.S. rate markets," Hardman said. "We think the Fed is closer to the end of their hiking cycle."
Futures tied to the Fed's policy showed a high probability that the central bank would cut interest rates as early as September, even though inflation was still running well above its two percent target. Many investors also expected the Fed to pause rate hikes per its next policy meeting.
On the other hand, central banks in other countries signaled that they would likely continue to hike interest rates. The Swiss National Bank, for instance, increased its benchmark rate by 50 basis points last month when the Fed opted for a modest 25-basis-point increase. Swiss banking officials had said that monetary tightening would resume even though the country also experienced banking stress.
Predictions of other currencies
The euro will continue its rally with the expectation of a downward trend in the dollar, said analysts. The currency briefly traded below parity against the dollar last year but is already up 2.5 percent so far in 2023.
Analysts forecast that the eurozone currency will trade around the current level of $1.09 within the next quarter before strengthening another two percent to trade at around $1.12 in a year.
The Japanese yen is still down 0.6 percent his year despite gaining over 2.5 percent last month. Its performance is still a significant improvement from last year when it hit 32-year lows due to rate differentials caused by Japan's ultra-dovish monetary policy. Forex strategists predict that the yen will gain almost six percent to trade around 125 per dollar in a year.
The dollar's weakness is also expected to boost the performance of emerging markets currencies, which analysts predict will post "modest gains" this year.
Some analysts warned that the projected upside for the other currencies was limited. They explained that the U.S. dollar maintained its strong footing for years despite previous predictions that it would weaken.
"We are more optimistic than the consensus for the dollar."
Adam Cole, Head of FX Strategy at RBC Capital Markets
RBC Capital Markets head of FX strategy Adam Cole predicted that the "big dollar losses" consensus would likely be false. He said the Fed would not deliver steep rate cuts as expected by the market.