Currencies: US dollar

Recent US macroeconomic data strengthens the view that the disinflationary process is well underway, with two key implications for the US dollar. Firstly, it suggests that the end of the Fed’s tightening cycle is getting even closer. Secondly, it increases the likelihood of disinflation happening without the need for a sharp slowdown in the US economy. In other words, weak US economic activity (but not too weak) and a more balanced monetary stance from the Fed are seen as negative for the US dollar. 

While it goes with our medium-term negative view on the US dollar, we see limited reasons for a sustained decline in the short term. Firstly, economic activity in the euro area and China is rather weak. In particular, China’s fiscal measures expected by the end of July may turn out to be more targeted than previously thought, which may lead to a very gradual recovery. Secondly, the EUR/USD rate seems to have overshot what is implied by interest rate differentials. Finally, while US external imbalances favoured a depreciation of the US dollar over time, the current account deficit (-3% of GDP in Q1) is not extreme relative to the long-term average (-2%).

The weak global economic outlook tends to favour a defensive tilt among currencies, especially if such weakness spills over into risky assets. 

Overall, on the back of the recent decline in the US dollar, which goes in line with our medium-term projections, we have decided to adjust our projections on the EUR/USD rate higher. The three-month projection on EUR/USD is adjusted to USD1.10, while the 12-month projection is set to USD1.18.