USD to strengthen at the start of next year before depreciating mildy in H2 2022 – MUFG

Market participants are still in the process of assessing the potential scale of the disruptive impact from the new Omicron COVID-19 variant and a further hawkish policy pivot from the Federal Reserve. Unless the Fed then expects US growth to slow sharply (worst case scenario) next year, economists at MUFG Bank expect the Fed to continue to tighten policy. It leaves room for US rates and the US dollar to rise further at the start of next year.

US dollar to trade at stronger levels through Q1 2022 

“We suspect that relatively quickly, the markets will revert back to being driven by expectations of a more active Fed in 2022 and this we believe will open up the scope for relative rate hike expectations to shift back in favour of the US dollar initially. Data of late indicate a strong Q4 GDP growth rate for the US which will encourage the Fed to taper QE faster.”

“But we do not believe a faster taper through Q1 2022 by the Fed will be followed by numerous (three) rate hikes and expect the Fed to prove much more cautious in raising rates and will ultimately deliver less than market pricing – perhaps just hiking once. This caution will prompt a repricing that ultimately results in USD depreciation. Hence, the depreciation we see will be largely delivered in H2 2022 but will also be relatively modest.” 

“Given the outlook is partly unsighted by the uncertainty of Omicron, we have had to make a key assumption that the new variant does not derail the prospects of recovery and reversal of monetary policy easing. That will initially favour the US dollar but Fed caution further into next year will see the dollar weaken in H2.”