The case for a stronger USD is compelling against the low yielding EUR, CHF and JPY – MUFG

The FX market is continuing to weigh up the risk of more persistent inflation. Lee Hardman, Currency Analyst at MUFG Bank, expects the US dollar to strengthen against the euro, the Swiss franc and the Japanese yen given that their central banks are set to keep a dovish stance shrugging off higher inflation. 

Market is expecting more hawkish Fed if higher inflation persists

“The Fed is beginning to display more concern over the risk that higher inflation could become more embedded in the economy. It provides justification for the Fed to begin QE tapering from next month and to bring QE to an end by around the middle of next year. That would then leave open the second half of next year for the Fed to begin raising rates if higher inflation proves more persistent than policymakers currently believe.” 

“The US rate market has already moved along way to price in this scenario with two 25bps now priced into 2022 followed by a further three 25bps hikes in 2023. It is continuing to place upward pressure on US rates.”

“Support for the US dollar from higher US yields has been dampened so far this month both by the improvement in global investor risk sentiment, and by similar rise in yields outside of the US on average in other G10 economies. As a result yield spreads have not moved decisively in favour of the US dollar.”

“The case for a stronger US dollar is more compelling against the low yielding G10 currencies of the EUR, CHF and JPY where market participants are more comfortable that their domestic central banks will keep rates low despite higher inflation.”