The dollar is currently in a depreciation phase since its mid-September peak (114/Dollar Index), but iBanFirst analysts anticipate that the most likely medium-term scenario will be an appreciation of the US dollar around 115 (dollar index). The expected evolution of the dollar will be fuelled by several structural underlying factors.
Since peaking in mid-September at around 114, the Dollar Index has been in a depreciation phase. This drop is partly explained by the easing of US inflation, which may lead to a slowdown in the monetary tightening cycle of the US Federal Reserve (Fed). The debate is not settled. There are two camps.
The first camp includes all those who think the dollar has already peaked in this cycle and will continue falling towards 100. They foresee a swift drop in inflation over the coming months, which would ease market strains.
The second camp includes those who, like us, think the recent depreciation is just a breather and the dollar index may appreciate again if the risks associated with the global recession materialise.
iBanFirst is convinced we face an economic universe where the dollar will remain strong for a long period and could top 115. Based on the real effective exchange rate (which measures one currency’s valuation relative to another), the US dollar is overvalued by 34% against the euro, for example. This is an historical high.
The underlying drivers of a dollar target of around 115
In absolute terms, inflation remains preoccupying. True, inflation is easing in the US from its peak last June. This has been confirmed by both the consumer price index (7.7% year-on-year in October) and the production price index (8% year-on-year over the same period). But the starting point (around 10%) does not technically leave the Fed any choices other than to continue tightening its monetary policy over the coming months (even if growth slows) to return to the explicit target of 4%.
The US trade deficit is a driver of a strong dollar (73.3 billion dollars last September). The Americans distribute an enormous amount of dollars for their imports (semiconductors, pharmaceutical products and electronics, in particular), and a portion of these dollars are recycled in the US market by foreigners seeking yield and safety. This is a phenomenon we have seen during past crisis periods and is in the process of happening again.
The US is less penalized by the energy crisis: this country is suffering less than many other developed economies from the energy crisis. This is a new development. The US has its own access to oil and energy resources and can drain strategic oil reserves if necessary to contain a surge in prices. This is what the White House has done since September 2021 (total of 212m barrels released over the period).
Lastly, the resurgence of Covid cases in China is another explanation of the dollar’s appreciation by a domino effect. Whereas China contributed of around 30% to world growth before Covid, this has since fallen to 10%. This means that, unlike in the crisis of 2007-2008, the country will not save the world economy this time round. And periods of economic turbulence tend to be synonymous with a strong dollar.