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Foreign exchange analysts at ING Bank N.V. have announced a review of their U.S. Dollar forecasts and told clients they have turned more constructive on the currency.
The shift in stance on the Greenback is particularly relevant for the bank's Euro-to-Dollar exchange rate (EUR/USD) forecasts, which have been lowered from a previous high-water target of 1.28.
"Having been bearish on the dollar since April 2020, this month we feel compelled to outline a more positive medium-term scenario," says Chris Turner Global Head of Markets and Regional Head of Research for UK & CEE at ING.
"At the heart of this is the likelihood that the Fed’s exit sequence from ultra-loose monetary policy is more compressed than they would have us believe," adds Turner.
The U.S. economy is currently generating inflation well above the Federal Reserve's 2.0% target, leading markets to expect higher interest rates at the Fed in coming months.
Traditionally, higher interest rates are deployed by central banks to cool economic growth which in turn puts a lid on price rises. Higher interest rates in turn attract foreign investor capital which bids up the value of the Dollar.
The U.S. consumer prices index rose at an annual rate of 5% in May, up from 4.2% in April and the highest since August 2008.
In response to the heating economy Fed policy makers at their June meeting brought forward their forecasts for the first interest rate rise to 2023 from 2024 previously, a move that coincided with a sharp appreciation in the U.S. Dollar.
The Dollar had been a laggard for much of 2021 but the shift in stance at the Fed meant it was one of the better performing currencies through the mid-year period, and analysts are increasingly of the view that the lows are in.
ING say they see the next Fed rate hike taking place in the third quarter of 2022, which means that if they are right the market will need to bring forward rate expectations once more which would likely generate further Dollar gains.
"The earlier-than-expected Fed tightening cycle suggests our prior end-2021 EUR/USD forecast of 1.28 was just too high," says Turner.
A shift in investor sentiment towards the Dollar has meanwhile been reflected in positioning data that shows the speculative segment of the market is now a net buyer of the currency.
The most recent set of positioning data from the CFTC showed positioning on the Dollar surged from a slight net short to a decent net long last week:
Image courtesy of Rabobank.
"The move follows the trend that has been in evidence since mid-June and the hawkish tilt from the FOMC. The change in positions has highlighted how poorly positioned the market was for the shift in tone from the Fed," says Jane Foley, Senior FX Strategist at Rabobank.
Despite a more constructive shift on the U.S. Dollar ING are nevertheless expecting EUR/USD to return above 1.20 over coming months.
"November and December are seasonally weak months for the dollar and assuming that the Eurozone recovery goes to plan, EUR/USD should still rally to the 1.23 area," says Turner.
Turner says 1.17-1.23 may well be the rough trading range for EUR/USD for the next six months.
The Fed is widely expected by the market to announce in detail how it intends to wind down its asset purchase programme at its September meeting, a process known as tapering.
Tapering is a necessary first step down the road to an eventual rate rise.
But Turner says tapering does not necessarily mean lift-off for the Dollar.
"The big, broad turn higher in the dollar should really start in 2Q22 – six months before the Fed starts tightening," he says.
Turner forecasts EUR/USD at 1.20 in one month, 1.23 in three months, 1.23 in six months and 1.20 in 12 months.