U.S. Dollar Embarks on "Prolonged Period of Depreciation" Predicts Wells Fargo

• GBP/USD forecasts show 1.26 on horizon
• EUR/USD to stay near current levels until H2
• As near-term USD weakness is seen to be gradual

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The U.S. Dollar will only fall gradually from here before embarking on a more pronounced decline in the second half of 2023, according to researchers at Wells Fargo.

The U.S. lender and global investment bank says the Dollar could struggle over the coming months as global economic growth improves and foreign central banks close the interest rate differential with the Federal Reserve.

"Given more resilient growth internationally and a hawkish shift by some foreign central banks in recent months (notably the European Central Bank and Bank of Japan), we believe the U.S. dollar has embarked upon a prolonged period of depreciation," says Nick Bennenbroek, an economist at Wells Fargo.

The Dollar was 2022's best-performing currency amidst rising U.S. interest rates and a global growth slowdown resulting from rising energy prices that sent inflation rates through the roof.

But the tide turned against the Greenback in the final quarter of the year as markets saw the peak in U.S. interest rates fast approaching amidst signs the U.S. economy would slow in 2023 and peaking inflation rates.

These themes are likely to prevail over the coming months but the Dollar's depreciation trend could fade following the strength of the decline seen through the turn of the year.

"In the short term, we expect U.S. dollar depreciation to be gradual as the U.S. economy falls into recession, while the Fed hesitates to lower interest rates prematurely," says Bennenbroek.

Wells Fargo expects the U.S. dollar's depreciation to gather pace again in 2024 as it believes the Fed will start cutting interest rates quicker than foreign central banks.

Markets are already anticipating up to three interest rate cuts at the Fed in 2023 as the central bank corrects rates in response to an economic slowdown and signs inflation is en route to target.

"We believe G10 and emerging market currencies can perform quite well against the dollar. In the G10 space, we have a particularly positive outlook on the euro and Japanese yen," says Bennenbroek. "The yield gap between U.S. Treasuries and German bunds has narrowed sharply."

Wells Fargo forecasts Sterling to hold above 1.20 over the forecast horizon and sees the Pound to Dollar exchange rate (GBP/USD) at 1.23 by the end of the first quarter of 2023, 1.24 by the end of the second quarter, 1.25 by the end of the third quarter and 1.26 by year-end.

Underscoring this forecast is Wells Fargo's revision higher for global growth, "including a more resilient outlook for the economies of the Eurozone, China and the United Kingdom".

"In the U.K., falling energy prices and slowing inflation should also prove to be less of a drag on real household incomes than previously anticipated, while the economy has shown a degree of resilience in recent months. We expect U.K. GDP to contract by 0.6% in 2023, a much smaller decline than our forecast of a month ago," says Bennenbroek.

The Euro to Dollar exchange rate (EUR/USD) is meanwhile forecast at 1.09, 1.10, 1.11 and 1.13 for the same timeframe.

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