"Dollar Strength Creates Tremors Across Markets"

- Dollar in demand
- Set to be best performer of June
- But Goldman Sachs says USD overvalued

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"Dollar strength creates tremors across markets," says Chris Beauchamp, Chief Market Analyst at IG, touching on the key global currency theme as the turn of month approaches.

The Dollar looks set to end June on a bullish note and is on course to stake a claim as the best performing major currency for the month, a performance that makes for a remarkable turnaround given the declines seen during the year to June.

"Money continues to flow into the US dollar, as the greenback continues its recovery from the lows of last week. The rosier US outlook is driving a renewed appreciation of US assets, even if the Fed has managed to muddy the waters on policy thanks to the recent FOMC meeting and the speeches following it," says Beauchamp.

The U.S. Federal Reserve's June FOMC meeting saw policy makers signal that the timing of the first interest rate in the post-Covid era is likely to come in 2023, a shift up from earlier expectations for a hike in 2024. 

The call was one that proved surprising to markets and the Dollar was bought as a result. 

Dollar strength leaves the Pound-to-Dollar exchange rate trading at 1.3836, down 2.60% in June. The Euro-to-Dollar exchange rate is meanwhile down by a similar percentage this month, coming in at 1.19.

Above: The performance of the Dollar over the past month.

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Although the Dollar has risen over recent weeks foreign exchange analysts at Goldman Sachs have said they are sticking with a view that the currency will ultimately lose value over coming weeks and months.

In a regular currency briefing, Goldman Sachs say they are maintaining a conviction view the longer-term U.S. Dollar trend will remain a bearish one.

However, they do concede that "the signal from the last FOMC meeting arguably truncated the risk of a sharp Dollar depreciation driven by high inflation and very low real rates, and should result in a clearer positive correlation between higher domestic inflation news and USD appreciation".

As a result, Goldman Sachs have revised several of their Dollar exchange rate forecasts to show reduced Dollar downside, in part to take on board their slightly revised Fed call that anticipates the prospect of interest rate rises at the Fed rising earlier than previously expected.

"As a rule-of-thumb, adding one additional Fed rate hike to end-2023 (around the 2y1y point of the rates curve) would raise the expected path of USD vs G10 crosses by 1.50-1.75% on our models," says economist Zach Pandl with Goldman Sachs.

But, "while there may be upside risks to the Dollar over the short-term, we continue to expect significant Dollar depreciation over the medium-term. The US Dollar is overvalued and arguably over-owned after a long stretch of US asset market outperformance during the last business cycle," he adds.

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Goldman Sachs are of the view other regions may offer increasingly competitive returns when contrasted to the U.S., due to relatively low nominal and real yields offered on bonds in the U.S.

Furthermore, strong growth and interest rate hikes overseas can offer upside for other currencies against the Dollar.

"We would caution against extrapolating the hawkish Fed signal too far, ahead of the substantial deceleration we expect into 2022," says Pandl.

Goldman Sachs forecast the Pound-Dollar exchange rate at 1.36 in three months, 1.40 in six months and 1.42 in 12 months.

The investment bank forecasts the Euro-Dollar exchange rate at 1.20 in three months, 1.23 in six months and 1.25 in twelve months.