Pound Sterling and Euro Won't Recover against Dollar Until Well into 2023, Shows Latest Wells Fargo Forecasts

• GBP/USD nadir near 1.14
• EUR/USD nadir near 0.96
• GBP/EUR seen flat for another year
• Fed to cut faster than other CBs in 2023
• Finally easing USD strength

 "Understand what the DXY is doing and you will know what 90% of the market is going to do" - Bernie Doran at Innovation Markets, a forex trade education provider.

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Timing the Dollar's unyielding rally remains one of the key questions for financial and global markets at present: there is a sense that the rally is nearing its top, but exactly where the top is and when it will finally turn is harder to divine.

One of America's largest banks have updated clients with their latest economic and financial forecasts and suggest patience is required.

Although they see the Dollar's turn lower starting at the end of 2022 further weakness in the Euro and Pound over coming weeks is still predicted, and it won't be until later in 2023 that a full recovery against the Greenback is recorded.

In their August financial research update, Wells Fargo says they "continue to forecast dollar strength through the end of 2022 as a result of a hawkish Federal Reserve. However, we now believe the dollar could peak in Q4-2022".

A look at the U.S. Dollar index (DXY) - a measure of USD performance - shows the currency has been trending higher since May 2021:

Above: The Dollar index at daily intervals.

The Dollar's long-term uptrend has been fuelled by expectations for the U.S. Federal Reserve to lead global central banks in race to raise interest rates in the face of rising inflation, culminating in a series of outsized 75 basis point hikes in 2022.

"We expect the U.S. dollar to strengthen moderately through the end of 2022 as the Fed raises interest rates 75 bps in September and policymakers reinforce their hawkish stance at the Jackson Hole Annual Symposium," says Nick Bennenbroek, International Economist at Wells Fargo Economics.

But financial markets are priced for around 62.5 basis points of tightening from the Fed in September, meaning Wells Fargo's bet for a 75bp hike is a hawkish one.

"As markets are underpricing the FOMC next month, we believe the dollar can strengthen through the end of Q3-2022 as financial markets react to a 75 bps FOMC rate hike in September," says Bennenbroek.

Such an outcome could therefore keep the Pound to Dollar exchange rate locked below 1.19 and the Euro to Dollar exchange rate below parity.

Wells Fargo economists now believe that a recession in the Eurozone will come sooner and believe the region will contract starting in Q4-2022.

"We continue to forecast recession in the U.K. as well as in Mexico and Brazil, and maintain our view for the U.S. to fall into recession by early2023," says Bennenbroek.

It is hard to be bullish Sterling and Euro under such circumstances.

Wells Fargo believes the Bank of England can hike interest rates further, but not as high as markets currently expect.

"We believe the BoE will lift policy rates to 3.00%, while market participants see a terminal rate of closer to 4.00%," says Bennenbroek.

The same goes for the European Central Bank (ECB).

"Markets potentially overpricing foreign central bank tightening from institutions such as the BoE and ECB can act as a tailwind to dollar strength through the end of this year," says Bennenbroek.

"As recession risks in Europe become more apparent and appreciated by investors, the amount of tightening market participants should expect from BoE and ECB policymakers could scale back. That repricing should result in the British pound underperforming and the euro falling further below parity against the U.S. dollar, and sustaining those levels for the next
couple of quarters," he adds.

Above: USD performance in 2022.

Looking further ahead, 2023 should see all central banks cut interest rates again as the sting of inflation fades.

Crucially though, the Fed will cut quicker, and this should fire the starting gun on a bigger retrenchment in the U.S. Dollar.

"While we also forecast other major central banks to ease monetary policy next year, we believe the Fed will likely cut policy rates quicker than peers. With interest rate differentials swinging back in favor of foreign currencies next year, the greenback should enter a period of cyclical decline against most G10 currencies as well as certain emerging currencies," says Bennenbroek.

Wells Fargo's forecasts for the GBP/USD see 1.1400 by the end of 2022, 1.1500 by the end of the first quarter 2023, 1.1600 by the end of the second quarter and 1.1700 by the end of the third quarter.

Their EUR/USD forecast profile shows 0.9600 for the end of the year, 0.9700 for the end of the first quarter 2023, 0.9800 by the end of the second quarter and 1.0000 by the end of the third quarter.

For those watching the Pound against the Euro the above profile suggests the current sideways drift between the two European currencies is likely to still be with us one year from now.

The above figures give a Pound to Euro forecast profile of 1.1875, 1.1855, 1.1836 and 1.17.