US Dollar Q3 2022 Forecast

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US Dollar Q3 2022 Forecast: Dollar’s Run Relies on Rates, Recession and Risk

Jul 1, 2022 | DailyFX
John Kicklighter, Chief Strategist

The Dollar performed exceptionally well through the first half of 2022 – and more broadly over the preceding year. The fundamental stars aligned between a leading Fed tightening regime, perceptions of a greater cushion for the US economy amid forecasts of a global slowdown and the reliability of the currency’s renowned safe haven status. All of these elements are still in play heading into the second half of the year, but the relative potential has deflated. The underwhelming follows through for the Greenback despite the Fed’s 75 basis point hike in June or during the S&P 500’s steep selloff in the first half of the same month likely indicates the limitations in support of the Dollar for the different dimensions. Can the benchmark currency extend its incredible rally into territory not charted in two decades or is it finding a peak?

RATE HIKES THAT AREN’T UNIQUE

In the past six months, the topic of inflation moved from scholarly debates among economists to mainstream fears over the country’s ability to absorb price growth that hasn’t been seen in four decades. Through the period, the Fed moved from confidence that inflation was ‘transitory’ to a hasty fight to head off the troublingly stubborn climb. The central bank started with a 25-basis point (bp) rate hike in March which it escalated to 50 bp at the next meeting in May and then a hefty 75 bp increase (the biggest in decades) at the June gathering. That is an aggressive policy move with swaps pricing in a resting point for the benchmark rate at 3.59 percent by year’s end with a range of 1.50 – 1.75 percent heading into the second quarter. That is extraordinary in historical terms; and in a vacuum, that could perhaps keep the Dollar a steady bullish trajectory.

Yet, exchange rates are not a vacuum. Rather they are determined on a relative basis. Though the Fed earned significant premium initially to the hard steer against inflation this year, many of its other major counterparts are catching up – or have already surpassed the outlook for the US. The RBNZ and RBA forecasts see their rates ending the year above the Fed Funds average rate, while the BOC and BOE are fairly close. That said, it is the ECB’s policies that most interest me for Dollar influence. While the ECB has been one of the most dovish central banks over the past decade, it has signalled capitulation to the fight inflation itself. As the European group (the second largest) moves up its forecast, it can materially dampen the perceived value to the Dollar via EURUSD.

CHART 1: RELATIVE MONETARY POLICY STANCE

Created by John Kicklighter

RECESSION FEARS ARE GROWING

Interest rates only matter as far as the markets are healthy enough to chase the higher returns. In the environment where fear prevails, it takes far more promise of income to dampen the threat that significant losses will result from maintaining exceptional exposure in the markets. There are a number of ways to measure risk, but the traditional macroeconomic outlet is through economic activity. At the IMF’s spring economic forecasts (referred to as the ‘WEO’), there was a global downgrade in forecasts, but the US received a smaller reduction than most counterparts.

The drums of economic retrenchment are growing louder and louder heading into the second half of the year, but the first vestiges of the contraction were not yet showing in official data. Instead, the signals were coming from sentiment surveys (e.g., consumer, business, CEOs, etc) as well as certain market measures (e.g., the 2-10 US Treasury yield spread). With the sense of impending impact, there is a diffusion of risk when it comes to relative disadvantage. In other words, the fears are not related to one economy or another, it simply weighs the global perception of risk collectively. As we start to see official readings of economic contraction that may lead into outright recession, we will see the relative status come into play. And, given the US and Dollar are already afforded some perception of resilience, there is more to lose than gain moving forward.

CHART 2: WORLDWIDE SEARCH INTEREST IN KEY TERMS

Source: Google Trends; Prepared by John Kicklighter

HOW MUCH SAFETY IS THE WORLD LOOKING FOR?

As inflation persists, financial accommodation retracts, the economy slows, we will see the capital markets grow increasingly unsettled. In moderate levels of risk aversion, there remains an appetite to look for relative safety and return. That nuance may present a country/currency with a comparable economic trajectory as the US but a greater rate of return, and direct capital towards away from the Greenback. However, the more intense risk aversion grows, the smaller the field of relevant safe havens becomes. At the more extreme end of the risk curve (risk aversion), the Dollar and US Treasuries / Money Markets are classified in the ‘last resort’ category. When the most important decision is liquidity and ability to stabilize capital holdings, the Dollar historically reverts to its frequently referenced haven status.

CHART 3: RELATIVE RISK POSITIONING OF KEY CURRENCIES/ASSETS

Created by John Kicklighter

Notably, though the US equity markets fell into bear markets through the first half of 2022, there wasn’t a sense of panic in the move. I am looking to measures like the VIX driving up to 50 – 70 or prime market yield spreads surging as indications that this degree of fear is entering the system. It’s worth pointing out that such intense measures of fear are destructive, but they are also shorter-lived periods.

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US Dollar Q3 2022 Technical Forecast: Does the Bull Stampede Have More Room to Roam?

Jul 2, 2022 | DailyFX
James Stanley, Senior Strategist

The bullish USD trend turned a year-old last month. And it can be difficult to put into scope everything that’s happened since then but, just last May, DXY was grinding at the same 90 level that had held the lows at the start of the year.

Sentiment at the time still felt overwhelmingly bearish in the Greenback. Covid numbers were still being counted and there was fear that the pandemic was about to rear its ugly head again, which only helped to keep the Fed in an ultra-dovish position. Sure, inflation had started to tick up: In May of last year, CPI had just been released for April at the tune of 4.2%. But – this was the first print over 3% and only the second over the Fed’s 2% target. The bank wasn’t worried and continued to shrug off the risk of higher rates of inflation as transitory.

But it’s during last Q3 when this theme really started to come to life. In July 2021, inflation data for June was released to the tune of 5.4% and the same number printed a month later, starting to establish a trend. By the time we got to September, the Fed was becoming more responsive, and it was the September FOMC rate decision in which the bank began to forecast actual rate hikes in response to that inflation, with the first expected to land at some point in 2022. The US Dollar broke out at that point and hasn’t really looked back since. I’m illustrating this period of time on the below chart with a blue box.

US DOLLAR INDEX (DXY) – WEEKLY TIMEFRAME (JUNE 2018 TO PRESENT)

Source: TradingView; Prepared by James Stanley

USD SINCE THE BREAK

Taking a step back to the monthly chart of the USD and it becomes clear that the currency spent much of the past seven years in a range-bound environment.

To be sure, there’s a fundamental drive there, often with the inter-play between the Euro and the US Dollar. But, given the trajectory of the shorter-term trend that’s now projecting a tangle with resistance in the not-too-distant future, this zone is worthy of a look.

There’s been a tendency for resistance to show above the 100 level over the past seven years and, bigger picture, this has been problematic pretty much ever since the Euro came into circulation. But now that we have such divergence between the US and European economy, the door may be open for a topside break.

For upcoming resistance, the 100 psychological level looms large and there’s a Fibonacci level at 101.80. Beyond that we have the 20-year high plotted around 103.54. A breach of that brings fresh multi-decade highs to the USD and I think this is a possibility for 2022 trade, although I’d anticipate it to be more of a second-half type of theme. At least I hope that it is, because if this develops faster it will send a very negative signal about global growth.

DOLLAR INDEX (DXY) – MONTHLY TIMEFRAME (1998- PRESENT)

Source: TradingView; Prepared by James Stanley

Q3 2022 FORECAST FOR THE US DOLLAR: BULLISH

I’m keeping the technical forecast for the US Dollar as bullish for Q3. There’s simply no sign yet that the trend is over and until there are more developments in Europe towards higher rates, it’s difficult to justify the expectation of significant change in this trend.

From a technical perspective, the response to the pullback in late-May is pretty much what one would want to see for bullish continuation scenarios. The pullback was almost a perfect 23.6% retracement, which was quickly followed by a push up to a fresh high. That fresh high printed at 105.79 and that level presents additional breakout opportunity if it’s traded through.

DOLLAR INDEX (DXY) – DAILY TIMEFRAME (2021- PRESENT)

Source: TradingView; Prepared by James Stanley