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Another year of dollar dominance lies ahead as the Fed hikes rates

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Reuters

Hari Kishan and Vivek Mishra

Publication date:

01/06/202246 minutes ago3 minutes read Join the conversation

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BENGALURU – Most currencies will struggle to make gains against the US dollar in the coming months as the anticipated monetary tightening by the Federal Reserve will give the greenback enough boost to extend its dominance well into 2022, said analysts.

Almost two-thirds of the 49 foreign exchange strategists surveyed by Reuters between Jan 4th and 6th said interest rate differentials would in the short term dictate sentiment in major foreign exchange markets, with only two being concerned about new flavors of coronavirus.

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The vast majority of analysts surveyed said that volatility in the currency markets will increase over the next three months, with this being the case for both major currencies and emerging market currencies well over 80%.

In the meantime, the Fed, now expected by traders, will raise interest rates https://www.reuters.com/markets/us/fed-may-need-hike-rates-faster-reduce-balance-sheet-quickly -minutes- show-2022-01-05 in March and starts to run down its asset holdings shortly afterwards, will give the dollar an advantage over other major currencies.

Financial markets are now pricing in at least three US rate hikes this year.

“The US dollar has risen sharply lately, mainly driven by widening interest rate differentials and inflationary dynamics in the US compared to other major markets such as Japan and Europe,” said Kerry Craig, global markets strategist at JP Morgan Asset Management.

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“The fact that the Fed is becoming much more restrictive and responding by falling much earlier than forecast a few months ago … (and soon) starting rate hikes should support the dollar in the first half of the year,” he said.

Median projections were consistent with this view as analysts do not expect most major and emerging market currencies to make significant progress against the greenback over this period.

While the dominance of the dollar, as in previous Fed tightening cycles, is almost universal, emerging market currencies are likely to feel it the hardest.

“The macro backdrop looks challenging for emerging market investments,” said Kamakshya Trivedi, co-head of global FX, rates and emerging markets strategy at Goldman Sachs.

“Growth is slowing from peaks as the reopening spurt fades globally, monetary tightening is underway, China has switched to a lower growth rate, and some all-too-familiar old-school EM problems like inflation, fiscal excesses,” and political instability are back on the table. “

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The emerging market currencies surveyed were projected to depreciate the tightly controlled Chinese yuan by almost 2% to 6.5 per dollar in a year. The Philippine peso, Malaysian ringgit and Indian rupee are also likely to decline by around 1%, or at best hold a range.

Turkey’s battered lira has been predicted to fall another 14% this year after plummeting 44% https://www.reuters.com/world/middle-east/turkeys-lira-weakens-further- inflation-policy-worries-2022-01-06 in 2021, the worst year since President Tayyip Erdogan’s AK Party took office in 2002, making it by far the worst performance in emerging markets.

Another high yield rand that is among the worst performing emerging market currencies in 2021 is expected to stay in a range for the next six months but will fall 0.4% to / $ 15.78 in a year.

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Most major currencies were also not expected to recoup their losses from 2021 in the next 12 months.

The euro, which lost almost 7% last year, is expected to gain almost 1.5% by the end of 2022. Among the major safe haven currencies, the Japanese yen is likely to trade at current levels and the Swiss franc is likely to fall around 3% a year.

While the general direction seems to be towards a strengthening of the dollar across the board as there is more clarity about Fed policies, analysts say many risks remain.

“Given the uncertainty about how economies will perform and how policy makers will react, we are more confident that currency volatility will be relatively high,” said Jonas Goltermann, Senior Market Economist at Capital Economics.

(For other stories from the January Reuters Foreign Exchange Survey 🙂

(Reporting by Hari Kishan and Vivek Mishra; survey by Sarupya Ganguly, Anant Chandak and Devayani Sathyan; editing by Ross Finley and Catherine Evans)

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