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- The US dollar could weaken 10%-15% by the middle of 2024, Stephen Jen at Eurizon SLJ Capital wrote in a note.
- As inflation continues to cool, the central bank could cut rates in 2023, which would lead to the dollar’s depreciation, Jen said.
- “As the USD loses cyclical support, the US’ familiar structural flaws might again become exposed, as the supportive ‘tide’ recedes.”
The US dollar could weaken by as much as 15% in the coming four-to-six quarters as inflation continues to subside and the Federal Reserve loosens monetary policy, according to a Tuesday research note by Stephen Jen at Eurizon SLJ Capital.
For February, inflation as measured by the consumer price index cooled in line with expectations, rising 6.0% year-over-year. That data arrived ahead of the Fed’s 25 basis-point rate hike in March amid the turmoil of the Silicon Valley Bank crisis.
Inflation notched a high for the cycle in June 2022, with CPI clocking in at 9.1% year-over-year — the highest rate since November 1981. By the fourth quarter of this year, Jen anticipates that reading to drop to below 4%.
“We expect US inflation to continue to decline at roughly the same pace as it rose in 2021 and the first half of 2022: historically, there has been scant evidence of downside stickiness in inflation, even if there is evidence of downside price and wage level stickiness,” Jen wrote in the note.
To Jen, who invented the dollar smile theory, the Fed, as well as the European Central Bank, is likely close to or already beyond peak hawkishness, and rate cuts are looming.
The central bank’s nine previous rate hikes, in addition to the tighter credit conditions sparked by the bank crisis, already signal inflation is trending to the downside, he added.
The next 250 basis points of adjustments to the federal funds rate, the strategists maintained, will be cuts.
The US Dollar Index—which measures the strength of the greenback against a basket of rival currencies—has declined 2.46% over the last four weeks after it notched a 7.9% gain in 2022. In the next 18 months, in Eurizon’s view, the currency “is vulnerable to substantial (10-15 percent) depreciation.”
Jen’s dollar smile theory, meanwhile, says the greenback strengthens when the US economy is either strong or weak, but slips when growth stagnates.
“The key point to make here is that, consistent with our Dollar Smile framework, fading inflation with a soft landing should push the dollar into the deep trough of the Dollar Smile,” the strategists said. “This could mean 10 percent generalised dollar depreciation this year, and more next year.”