Not High Enough: US Dollar Forecasted to Deliver More Gains by Bank of America Exchange Rate Analysts

The viewpoint sets us up for the central thesis of BofA's latest forecast note on the US dollar - that there are more USD gains to come on global exchange rate markets.

"We expect further dollar strengthening ahead as the liquidity rotation continues," says analyst Gustavo Reis writing in BofA's Global Economic Weekly.

Before we hear the reasoning behind the bullish USD forecasts, here are the latest forex market mid-rates for your reference:

• The British pound to dollar exchange rate (GBP/USD) conversion is 0.12 pct lower on a daily basis. 1 GBP = 1.6222 USD.
• The euro to dollar exchange rate (EUR/USD) conversion is 0.50 pct lower, 1 EUR = 1.2622 USD.
• The US dollar to Canadian dollar exchange rate (USD/CAD) conversion is 0.15 pct higher, 1 USD = 1.1181.

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The Pace of Appreciation Picks Up

Statistcs show the US dollar basket has climbed by close on 7pct this quarter, BofA reckon the move is small by historical standards but the pace is noted to have picked up in recent weeks.

Driving the USD rally is comparatively robust growth and firming interest rate hike expectations.

The US dollar successfully halted and then reversed the rally in the British pound while making strides against the Australian Dollar, Japanese Yen and the Euro in G10, and against the Brazilian Real, the South African Rand and the Turkish Lira in EM.

Forecasting the US Dollar Gains to Continue

The USD strength partly reflects the global liquidity rotation suggest the team at BofA.

"We find that shifting interest-rate differentials account for about a quarter of the USD rise against G10 currencies over the past two months. With the liquidity rotation likely to continue, we see further USD strength ahead," says Reis.

But, Will the US Fed Torpedo the Rally?

Has the USD risen too much, too fast?

Reis points out to us that the ralling dollar may cause a headache for the US Federal Reserve, particularly if it starts to price US products out of the global market.

"The heads of Federal Reserve Banks in New York and Atlanta noticed this week that a stronger dollar could hurt exports and weigh on import prices. These comments suggest that, if extended and sustained, the ongoing USD move could affect the Fed’s exit strategy," says Reis.

We saw how central bank intervention can hit currencies - look at how the New Zealand and Australian dollars were hit this week as their respective central banks made efforts to talk their currencies lower.

Could this soon be the case with the US dollar?

"At this stage, however, we see little reason for concern. Very low FX passthrough to import prices in the US has been a long-held stylized fact," says Reis, "moreover, simulations with a global trade model reveal that USD changes have limited impact on trade volumes."

Forecasting Euro Dollar Lower in 2015

What does this all mean for the valuation of the dollar, particularly against the euro?

"The US economy appears to be running at about 3.5% pace in 3Q, cementing the robust 2Q pickup. This contrasts with moderate growth in the euro area and Japan, supporting the ongoing liquidity rotation. With further USD strength expected ahead, our G10 FX team sees the EUR easing to 1.25 by 2015," forecasts Reis.