Most currencies will struggle to make any gains against the U.S. dollar in the coming months, as monetary tightening expected from the Federal Reserve will provide enough impetus to extend its dominance well into 2022, analysts said.
Nearly two-thirds of 49 foreign exchange strategists polled by Reuters between Jan. 4 -- 6 said interest rate differentials would dictate sentiment in major FX markets in the near term, with only two concerned about new coronaviruses variants.
The vast majority of analysts said that volatility in FX markets would increase over the next three months, with well above 80% saying so for both majors and EM currencies.
The Fed, now expected to raise interest rates in March and begin reducing its asset holdings soon afterward, will give the dollar an edge over other major currencies.
Financial markets are now pricing in at least three U.S. rate hikes this year.
There is a lot of U.S. dollar strength of late, mainly due to the widening interest rate differentials and inflation dynamics in the U.S. relative to other major markets like Japan and Europe, said Kerry Craig, global market strategist at JP Morgan Asset Management.
He said that the Fed is becoming more hawkish and reacting to that by tapering much sooner than forecast a number of months ago and soon starting raising rates should support the dollar over the first part of the year. Graphic: Reuters Poll: Outlook for major currencies, https: fingfx.thomsonreuters. com Gfx polling znpnelkxrvl Reuters 20 poll 20 -- 20% 20 Outlook 20 for 20 major 20 currencies. PNG Median forecasts lined up with that view, as analysts do not believe that most major and emerging currencies will make a significant move against the dollar during that period.
Emerging market currencies are likely to feel the most of the dollar's dominance, as in previous Fed tightening cycles.
Kamakshya Trivedi said the macro backdrop for emerging market assets is challenging, as co-head of global FX, rates and EM strategy at Goldman Sachs.
Growth is slowing down as the reopening boost fades across the world, monetary policy tightening is under way, China has moved to a lower gear of growth and some old-school issues like inflation, fiscal overreach and political instability are back on the table. Reuters Poll: Major Currency Market Outlook, https: fingfx.thomsonreuters. The tightly-controlled Chinese yuan was predicted to depreciate nearly 2% to 6.5 per dollar in a year, according to Reuters 20 Poll 20 - 20 Major 20 currency 20 market 20 outlook.png The Philippine peso, Malaysian ringgit and Indian rupee were expected to weaken about 1% or at best cling to a range.
Turkey's battered lira was projected to drop another 14% this year after plunging 44% in 2021, its worst year since President Tayyip Erdogan's AK Party came to power in 2002, making it the worst performer in emerging markets.
South Africa's rand, another high-yielder but among the worst performing emerging market currencies in 2021, is set to remain rangebound in the next six months but falls 0.4% to 15.78 in a year.
Most major currencies were not expected to recover their 2021 losses over the next 12 months.
The euro, which lost nearly 7% last year, is projected to gain a little under 1.5% by the end of 2022. The Japanese yen was expected to trade around current levels and the Swiss franc to drop around 3% in a year.
There is more clarity on Fed policy and analysts say there are plenty of risks that remain despite the general direction of travel being for the dollar to strengthen.
Jonas Goltermann, senior markets economist at Capital Economics, said we are more confident in our view that currency volatility will be relatively high because of the uncertainty around how economies will evolve and how policymakers will respond.