FX Viewpoint 7 Jan 2022 | USD: Gradually gaining strength in 2022 | Article – HSBC VisionGo
- The USD ended 2021 in a strong position and its outlook for 2022 is promising, but we need to keep it in perspective
- Global growth is slowing but is expected to be above trend, limiting the degree of the USD outperformance
- With Fed rate hikes in the price, the USD is unlikely to rise significantly, unless markets estimate a higher terminal rate
Softening global growth and the Fed’s policy normalisation should continue to support USD strength in 2022, albeit in a more gradual manner
The USD had transitioned from a weaker to a stronger state in 2021 (Chart 1), and its outlook for 2022 is promising. Our central argument rested on two factors coming together to support the USD: the moderation in global growth and the Federal Reserve (Fed) embarking on a gradual path towards rate hikes. However, we need to keep things in perspective.
A more pronounced global slowdown (which is not our central scenario) could see a much stronger USD
The global economy has been slowing but is expected to remain above trend in the coming years (Chart 2). This means that there should be a limit to how far the USD should rally from cooling global growth alone, especially if the trend is reverting to a longer-term path. If we believed a more pronounced slowdown was on the cards, then we would have already adopted a much stronger USD view.
If market terminal rate does not increase, gradual USD strength is more likely than a meaningful acceleration, in our view
Besides, the Fed’s policy outlook is clearly essential. The 14-15 December Federal Open Market Committee (FOMC) meeting was undoubtedly a hawkish step, relative to the 2-3 November’s meeting. Apart from the announcement of faster tapering, the December “dot plot” (i.e., interest rate projections, but the projections are not a policy commitment rather they reflect the personal views of policy makers) signals three 25bp hikes in 2022, plus three more in 2023. The USD benefited from Fed rate hikes being priced in, but a more significant rally will be harder if the market’s estimate of the terminal rate does not rise, all things being equal. This does not mean the broad USD should now start weakening again. Instead, its degree of outperformance could become more associated with the levels of short-term yields. But this also suggests slower USD gains are more likely versus other major currencies.