Is the US dollar in the final innings of a recent surge?

Despite the US economy showing signs of cooling, the US$ is on a roll and has soared against major currencies from Europe’s 19-member euro to the Chinese Renminbi. 

Kamakshya Trivedi, head of Global Foreign Exchange at Goldmans Sachs attributes the US$ rally to the Federal Reserve (The Fed) hiking interest rates more aggressively than some other central banks, in an attempt to curb inflation.

Kamakshya also reminds investors that the US$, typically regarded as a safe-haven asset, tends to perform well when there are concerns of global recession.

“The dollar, which is seen as a haven during turmoil, has also risen as concerns grow that the shock in energy prices will stall economic growth in many parts of the world,” notes Kamakshya.

Is the US$ now past peak?

However, Kamakshya is witnessing signs that the dollar’s rise is in its “later innings” of a recent rally.

Kamakshya is flagging an end the US dollar’s recent rally after hitting extreme levels against currencies like the Japanese Yen (JPY) or the British pound (GBP), which has traded at its weakest level against the greenback since Margaret Thatcher was the U.K. prime minister. 

Having strengthened around 15% this year, and 20% since the start of 2021, Kamakshya believes the US$ now looks overvalued.

“Maybe not quite as overvalued as previous peaks but… when you look at the individual currency pairs… versus the yen or versus the pound, you are at levels that look relatively extreme,” Kamakshya notes.

But that said, with the Fed continuing to be on the front foot when it comes to its policy-tightening process, Kamakshya still thinks the US$ has a bit more room to strengthen.

Other currency pairs on radar

Kamakshya reminds investors that much of what happens to the broad dollar is going to be highly correlated with what happens to the euro and the euro area outlook.

With Goldman’s expecting a recession in the euro area, Kamakshya expects the euro to trade below parity for the next three months or so.

The Chinese Renminbi (RMB) is another place where Goldman’s expect to see more weakness and more US$ strength over the next two to three months. 

“At a very simple level, it reflects the fact that China’s economy is also struggling somewhat, both because of the successive local lockdowns on account of the zero-Covid policy alongside continued troubles in the domestic property sector,” Kamakshya notes.

Binary opposites

Kamakshya also reminds investors that the difference in relative policy settings is perhaps clearer in China than most places.

For example, while the Fed that is raising rates even with the US economy slowing, the People’s Bank of China is lowering rates given the kind of struggles the economy is facing. 

“The upshot of those two things is that we expect the dollar-Renminbi cross to continue moving higher and the Renminbi to continue to weaken.”