A more hawkish scenario could see the US$ climb another 5% to 7%: Goldman Sachs

Despite recent rises, Kamakshya Trivedi, head of global foreign exchange at Goldman Sachs has another couple of percent dollar appreciation baked into US$ forecasts for the next few months.

However, under a more hawkish scenario, where US inflation is more entrenched, and US Federal Reserve (the Fed) needs to go further and keep rates higher for longer, he foresees another 5% to 7% appreciation on the US$.

Kamakshya believes the underlying weakness currently experience by developed and emerging market currencies reflects their difficulty matching the combination of solid growth and the hefty 75 basis point Fed hikes.

“Inflation is to some extent a global problem... but the Fed just appears to be less constrained than other central banks in terms of moving policy tighter,” Kamakshya notes.

Implications

Kamakshya reminds investors that above target inflation remains the primary focus of US policymakers. What that means is the downward growth effects are somewhat second order.

“…the fact that there is an inflation benefit from that stronger dollar is going to be the main thing that policymakers in the US are going to be concerned about,” Kamakshya notes.

The flipside of a strong US currency, notes Kamakshya is the headache it creates for other parts of the world.

Unhelpful dilemma

While a higher US$ benefits US inflation, what it also does is complicate the tradeoff that a lot of other countries currently face.

“They have a somewhat unhelpful dilemma; either they accept a much faster depreciating currency, or they need to move rates up fast enough to either keep pace with the Fed or even outpaced the Fed,” notes Kamakshya.

“…which may not be appropriate for their local economic conditions either because the domestic economy is not as strong as the US or because underlying inflationary pressures are not as strong as the US.”

Currency intervention

Currency intervention is one way of trying to make that tradeoff between tightening policy and accepting a weaker currency - to improve the terms of that trade off - and Kamakshya wouldn't be surprised if this becomes more prevalent.

However, one of the challenges notes Kamakshya is whether these interventions will work.

For example, while interventions can slow the pace of the depreciation experienced by currencies, Kamakshya doubts they'll change the direction they're travelling in until the underlying fundamental macro and policy drivers change.

Widening gap

As a case in point, the big reason why the Japanese Yen is appreciating is that even as the Fed hikes, the Bank of Japan has a policy of yield curve control.

They are keeping the yields capped and not moving policy tighter.

The net effect is that the interest rate gap between the US and Japan keeps widening and pushing towards a weaker currency.

“… in a nutshell the number of the rules we've seen in these currency crosses with respect to the US$ have been extreme but their explainable based on the macro and policy differences,” notes Kamakshya.

While more individual intervention or one directional intervention is possible, he doesn’t believe the stars are aligned for more coordinated [central bank] intervention that includes the US.

Dollar boom end

Kamakshya doesn’t expect to witness an end to the US$ boom until there’s convincing evidence inflation in the US is peaking - as this will ultimately see the Fed pause its hiking cycle.

“But we also need to see better news elsewhere, we need to start seeing a recovery in global economies for the US$ to start to peak and move lower.”

Source: Trading View.