- The USD had been on a steady upward path since January this year
- But easing inflation fears over the past month have caused the USD to weaken
- Our analysis suggests that the USD will remain under pressure in the near term
- But we expect USD strength to remain a feature of 2023
Up, up and away
In stark contrast to almost all asset classes, the strength of the US dollar had been relentless throughout most of 2022. The DXY index, which measures how the USD is performing relative to a basket of other currencies, showed a rise of 18.5 percent from January to end-September 2022.
Figure 1: US Dollar Index (DXY) (Percentage change)
Source: MarketWatch as at 5 Dec 2022
This commanding position compared to other currencies had been driven by four key factors:
- Returns - Most obvious of course is the high level of US interest rates, prompting savers around the world to make a dash for the dollar. Having raised rates to curb inflation, the US Fed Funds rate for 2022, at 4.4 percent, is one of the highest in the world. This compares to the ECB’s 2.0 percent, the UK’s 3.5 percent, and Japan’s 0.0 percent.
Figure 2: Global yield spreads: Central Bank rates for 2022, 2023 and 2024
Source: UOBAM
- Fundamentals - While analysts have not ruled out the possibility of a US recession, the economy there is still offering better prospects than many other major developed countries.
Figure 3: IMF forecast: 2023 real GDP growth by country
| Germany | Japan | France | UK | US |
| -0.3% | 1.6% | 0.7% | 0.3% | 1.0% |
Source: International Monetary Fund
- Technicals - Until recently, daily DXY technical charts had suggested that USD bulls would continue to gain ground. Having managed to cross one resistance level after another, technical analysts were confident of an extended upward trend.
- Safety - Also in the USD’s favour is its traditional safe haven status. The dollar has a tendency to perform well in a crisis due to its high liquidity and investor demand for US Treasuries. The USD was therefore a beneficiary of 2022’s market turbulence.
A kink in the armour
However, the USD hit a wall in early November following the news that US inflation had eased further. This helped to give markets more confidence that prices had peaked and emboldened hopes that future interest rate hikes by the Fed would become less aggressive.
The correction in the US Treasuries market and USD happened more quickly than many traders were expecting. Caught by surprise, many traders with positive USD views were forced to sell down their positions, further accelerating the USD decline.
As a result, since its November high, the DXY has corrected by almost 10 percent, with many Asian currencies benefitting from the USD weakness. Just last week, the USD declined by a further 1.5 – 3.0 percent against the Thai Baht (THB), Malaysian Ringgit (MYR) and Indonesian Rupiah (IDR).
Turnaround not expected in the short term...
For the rest of December, we do not expect the USD to show a substantial recovery. Over the past 47 years from 1974 - 2021, our analysis shows that the USD has risen only 35 percent of the time. Over this period, returns in the month of December has only averaged -1.0 percent.
Based on this historical performance, seasonality factors and falling yields, we remain bearish on the USD over the short term, and we would resist reinstating any USD positions in December.
...but USD strength expected to resume in 2023
However, we note that even if the US Fed stops its rate hikes altogether (which is unlikely), this does not mean that the USD’s rise is at an end. Our analysis of the previous seven rate hike cycles suggest that the USD typically continues to strengthen for another six months following the Fed’s last rate hike.
There are also few signs that the factors supporting the USD are currently at risk. US interest rates may not rise much further from this point but are likely to stay high for some time. The USD also stands to benefit as the clouds of a global economic slowdown continue to hover.
As such, we are still constructive on USD strength in 2023 and we would view any extended dips as opportunities to add on to USD positions.
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