Dollar Turnaround Likely Mid-year says Westpac

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The Dollar will turn tail and retreat from around mid-year says analysts at Westpac, at which point the under pressure Pound could make a more sustained recovery.

The Pound to Dollar exchange rate has been under substantial pressure over recent days with markets pushing the pair to fresh two year lows in the wake of May's Bank of England policy decision.

But the exchange rate has been in decline since May 2021 when a broader Dollar rally kicked in and ultimately continues to this day, achieving a new 19 year high on May 09.

It is therefore the Dollar juggernaut that would need to be stopped and forced into retreat if the Pound-Dollar rate is to make a more sustained recovery.

"The market’s bid for the US dollar remains strong. But as uncertainties recede from mid-year, the trend is expected to reverse," says Elliot Clarke, a macro strategist at Westpac in Sydney.

The Dollar has rallied on a combination of U.S. economic outperformance, associated expectations for higher Federal Reserve interest rates and a major retracement in global investor sentiment.

By turning the taps off the Fed is draining liquidity from the global economy, at the very time it grapples with growth concerns related to China's Covid response and the war in Ukraine.

This backdrop is a highly bullish one for the counter cyclical Dollar.

"US rate expectations at fever pitch and the market’s acute concerns over China’s COVID-zero policies have also supported the US dollar," says Clarke.

The U.S. Dollar index - a measure of broader Dollar value based on key Dollar exchange rates - rose to its highest levels since 2003 on May 09 when it hit 104.18.

Above: The Dollar index reached a new 19-year high on May 09.

Westpac says the Dollar index's strong rally will however ultimately be challenged when two important components of that index refine their feet: Sterling and the Euro.

"The concerns that have hit Euro and Sterling are expected slowly to abate laying a foundation for a reversal," says Clarke.

The two European currencies are expected to recover against the Dollar by about 3% into year end, a view that relies on risks to the regional outlook dissipating and a broadening of the global recovery.

The assumption is that the regional risk posed by the war in Ukraine will fade as a preeminent concern for markets.

"If the downside for the Continent from Russia’s invasion of Ukraine were to reverse, Euro would outperform over the period," says Clarke.

Westpac forecast the Euro-Dollar exchange rate to end 2022 at 1.09 and to push higher to 1.15 through 2023.

The Pound to Dollar exchange rate forecast is meanwhile forecast to rise to 1.27 by the end of 2022 before extending to 1.34 by the end of 2023. (Set your FX rate alert here).