US dollar set to weaken due to global economic headwinds

Cooling labour market, slowing inflation and possibility of early rate cuts by Fed will weigh on the currency

The US dollar is expected to fall further against key currencies over the next six to 12 months, according to UBS. AFP

The US dollar remains under pressure and is expected to fall further against key currencies over the next six to 12 months, according to Swiss lender UBS.

This is due to many reasons such as the potential shrinking of the US growth premium, a cooling labour market, slowing inflation and the possibility of the Federal Reserve cutting interest rates before other major central banks, a report by UBS Wealth Management said.

“We maintain our least preferred rating on the greenback and instead favour the Australian dollar and the Japanese yen,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.

“We also continue to like gold as an attractive portfolio diversifier, forecasting the price of the precious metal to hit $2,200 per ounce by March 2024.”

The US dollar has been softening as investors take stock of weak economic data with the US Federal Reserve possibly set to pause interest rate increases after its expected 25 basis point increase next week.

As the Fed raised rates to fight inflation last year, overseas investors piled in seeking a higher rate of return, driving the dollar to a 20-year high in September.

However, cooling inflation will allow the Fed to now embark on cutting interest rates, thereby weakening demand.

The US Dollar index — a measure of the value of the dollar against a weighted basket of major currencies — is now a touch higher than its recent one-year low, according to UBS.

Since September, it has fallen close to 11 per cent, the lender said.

“The US has enjoyed a growth premium relative to the rest of the developed world in recent years, but we believe this will erode in the coming months,” the report said.

“While the data remains noisy, the trend is for a weakening US economy.”

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On Friday, the S&P Global flash US Composite purchasing managers' index came in above expectations at 53.5 (versus 51.2 expected), driven by the services sector.

However, the Institute of Supply Management manufacturing PMI for March was at its lowest level in nearly three years, while the services PMI dropped to a three-month low and other data released last week also pointed to weakness, UBS explained.

“Taken overall, we expect a falling growth differential between the US and Europe — given that various European economies have already suffered downturns, whereas the US is only about to enter this phase,” the report said.

UBS estimates a cooling US labour market and inflation to also likely weigh on the greenback.

The March US labour report showed a 236,000 increase in non-farm payrolls, the smallest since December 2020.

The latest Job Openings and Labour Turnover survey data showed lower-than-expected job openings and last week’s weekly jobless claims showed an increase of 5,000 to 245,000 claims, suggesting a softer US labour market, the Swiss lender said.

Also, headline inflation in the US declined to 5 per cent annually, the lowest since May 2021.

The possibility of the Fed to cut rates ahead of other major central banks also poses a headwind for the dollar, the report said.

While the US central bank looks set to raise rates by another 25 basis points in May, it is coming closer to the end of the tightening cycle against a slowing growth backdrop.

Conversely, recent comments from European Central Bank officials have been “more hawkish”, suggesting that the job of tightening monetary policy in the eurozone is not yet done, UBS said.

“The US dollar remains least preferred in our global strategy, and we now forecast the EUR/USD, the GBP/USD, and the USD/CHF to reach 1.16, 1.33 and 0.84, respectively, by year-end,” the bank said.

“We have upgraded the Japanese yen to most preferred, as we expect the Bank of Japan to eventually follow all other G10 central banks and tighten its ultra-loose policy.

“We keep the Australian dollar as most preferred. We think the currency is best placed to benefit from China’s economic recovery among G10 currencies, while the domestic economy is expected to experience a soft landing.”

Gold continues to shine

Meanwhile, economic factors are taking over from financial speculation as the main driver of demand for gold, Swiss private lender Lombard Odier said in a note on Tuesday.

"For nearly 14 years, exceptionally accommodative monetary policy, strong consumer spending and financial demand dominated this rationale for buying gold," the note said.

"With central banks having reversed course with higher rates and tightening lending conditions since early 2022, the prospect of peaking real rates and a weakening US dollar are now driving prices."

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Although nearly three-quarters of physical demand for gold globally remains for jewellery, coin or ingots, recent price increases also reflect central bank buying, which is at its highest levels since 2010, Lombard Odier said, quoting the World Gold Council.

"The risk of recession, combined with an eventual peak in real interest rates, plus a weakening US dollar, should all continue to support demand for gold, and the potential for the metal to trade higher over the rest of the year," the note said.

"As a result, we have raised our target, and see gold reaching $2,100/oz by the end of 2023, from a prior target of $1,940/oz."