Aug 21 2024: Nomura analysts, in a note dated Tuesday, projected ongoing weakness in the U.S. dollar, particularly in Asian markets. This outlook is influenced by several macroeconomic factors, adjustments in market positioning, and portfolio reallocations that are expected to exert downward pressure on the USD in the coming months.
One of the key drivers behind this forecast is the anticipated narrowing of the growth differential between the U.S. and Europe, which has been a major factor in USD strength. The U.S. is expected to see its growth outperformance diminish, with the GDP growth gap between the U.S. and the EU forecasted to narrow from 1.6% in Q2 2024 to 0.6% in Q3 2024 and 1.0% in Q4 2024.
“This could support EUR/USD, and our discussions with market participants indicate potential positioning risks towards a higher EUR/USD if spot breaches recent highs of 1.1139 in December 2023 (and 1.1276 in July 2023; last at 1.1077),” the analysts noted.
Another factor contributing to the anticipated USD weakness is significant shifts in speculative positioning. While positions have been reduced, Nomura analysts see potential for these positions to turn short on the USD. This could be driven by increased portfolio allocation towards Emerging Markets (EM) in Asia, as well as unwinds of USD accumulation by corporates, retail investors, and life insurance companies.
Substantial USD hoarding in Asia, particularly in China, Taiwan, and Korea, may begin to unwind, adding further pressure on the USD. Additionally, foreign portfolio investments into Asia are expected to increase, driven by a recovery from outflows that began in July 2024. Despite recent net foreign equity outflows in Taiwan and Korea, signs of a rebound could lead to increased capital inflows into Asian markets. Real money investors have maintained underweight positions in Asian bonds, with potential for reallocation, especially in markets like Indonesia.
Furthermore, Asia’s financial markets are still recovering from significant outflows experienced during the COVID-19 pandemic, which could further support a weaker USD as these markets stabilize.
Historically, the USD has tended to weaken during the period leading up to and following the first Federal Reserve rate cut. With the Fed expected to begin its rate-cutting cycle in September 2024, Nomura anticipates further USD weakness, particularly against Asian currencies. The past five Fed rate cut cycles have shown that USD/Asia currency pairs weakened by an average of about 2% in the month before and after the first Fed cut. Additionally, most Asian central banks are unlikely to actively buy USD during the early stages of an Asia FX recovery, as many Asian currencies remain undervalued according to various valuation metrics.
China’s economic situation remains a critical factor. Nomura suggests that a significant policy package aimed at stabilizing the property market could be introduced by the end of the year, which would likely support further USD weakness. A more stable Chinese economy could boost confidence in Asian currencies, exacerbating the USD’s decline in the region.
The upcoming U.S. presidential election poses additional risks to the USD. While current polls suggest a potential Democratic win, the uncertainties surrounding a possible Trump victory could lead to USD volatility. If Trump were to focus on issues such as geopolitical tensions, pressure on the Federal Reserve, and efforts to weaken the USD, there could be further downside for the currency, particularly if these policies are prioritized early in his term.
