Most roads lead to a stronger dollar
“It now looks as though the Fed may hike rates next summer. Good growth momentum going into 2022 (we forecast GDP at 5%) backed by strong corporate and consumer balance sheets should mean that pricing power holds and inflation stays above 3% all year. A stronger dollar can play a role in tightening monetary conditions.”
“Pricing of the ECB policy path fell foul and at one point nearly 30bp of tightening was priced in for 2022. We view that pricing as extreme and unlikely, although it may take eurozone inflation dipping into next spring before the market backs away from that kind of pricing. The eurozone is still expected to run a 0.5% of GDP negative output gap in 2022 and the ECB has made it pretty clear it does not want to repeat the mistakes that Trichet made by tightening policy in July 2008.”
The main risk to the above scenario is probably stagflation, where early hikes to address a transitory price shock trigger a recession. The current Fed seems light years away from the Volcker Fed of the early 80s, thus we would see this scenario as unlikely. Even if it were to materialise, stagflation would be negative for risk assets and probably provide support for the anti-cyclical dollar.”
“Perhaps the only scenario for a much stronger EUR/USD in 2022 would be a strong global recovery, a eurozone renaissance and a Fed turning dovish. With supply chain disruptions expected to weigh on growth in manufacturing-heavy Europe next year, such a scenario seems unlikely.”
“ Recent terms of trade changes have depressed EUR/USD fair value to around 1.10. That is our year-end 2022 forecast which is well below the consensus of 1.18.”
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