Different from the clear macro trading theme of "inflation + deflation" in 2022, in the first half of 2023, the market has different expectations on the monetary policy expectations of overseas central banks, and the prices of various assets have changed from "unilateral" in 2022 to "volatile" ". Looking ahead to the second half of 2023:
U.S. dollar index: In the absence of significant differentiation in fundamentals and monetary policy, the U.S. dollar index is unlikely to have a trending market, or is still dominated by range-bound markets. The current macro liquidity is still abundant, and the centralized issuance of U.S. debt has limited impact on the U.S. dollar index.
Euro: European economic momentum is slightly stronger than that of the United States, but the rate of inflation decline is accelerating. The hawkish stance of the European Central Bank will soften, and the euro is expected to fluctuate. As a positive stock market-sensitive currency, a recovery in global stock markets will boost the euro.
Sterling: The pound is supported by hawkish expectations in the short term, but is dragged down by fundamentals and fiscal deficit reduction in the medium term.
Yen: Before the market re-questioned the position of the Bank of Japan, the trading logic of multi-day stocks + short yen continued. In the medium term, the Bank of Japan's increased tightening and the reversal of carry trade will promote the trend appreciation of the yen.
Hong Kong dollar: In the second half of 2023, the Fed is likely to remain on a tightening track, and the Hong Kong dollar may still touch the 7.85 weak-side convertibility guarantee again. However, the U.S. inventory cycle shows signs of bottoming out, and the Hang Seng Index is also expected to regain the favor of foreign capital, which in turn will drive the appreciation of the Hong Kong dollar in stages.
1. Review of the first half of 2023: the US dollar fluctuates weakly as expected
Since 2023, as the Fed’s interest rate hike cycle draws to a close, the market’s attention has been drawn to the deterioration of U.S. fundamentals, and the main trading logic has repeatedly jumped between the Fed’s “raising interest rates to fight inflation” and “cutting interest rates to stabilize the economy”. The European and American banking crisis that broke out in mid-March and the approach of the "X day" deadline for the US debt default exacerbated market volatility. In the absence of significant tension in the overall macro liquidity of the US dollar, the US dollar index has not been greatly boosted, and the overall shock is in the range of 100-106.
The sideways arrangement of the U.S. dollar index has brought some non-U.S. currencies a window to do more. The UK economic surprise index was superior to that of Europe and the United States for most of the first half of the year. The superimposed high inflation fever made the market aggressively bet on the prospect of its central bank raising interest rates, and the performance of the British pound was extremely outstanding. Another typical example is the Japanese Yen. When risk incidents occurred frequently in the European and American banking industries, the safe-haven status of the yen was highlighted; until the Bank of Japan took a firm stance, the yen quickly lost its gains. In contrast, since the Australian dollar has basically digested most of the benefits related to China's reopening, it failed to seize this opportunity and even followed the dollar's depreciation.
2. G7 exchange rate outlook for the second half of 2023
2.1 U.S. dollar index: range-bound
In terms of relative economic performance, the OECD expects the United States to maintain a relatively better growth performance in the first three quarters of the year. But the relative growth of the U.S. economy will underperform other advanced economies in the fourth quarter. Judging from the relative performance of the economy tracked by the Economic Surprise Index, the current round of relative strength in the United States may last for a long time and is expected to continue into the third quarter, but it is more likely to weaken again in the fourth quarter, which is consistent with the OECD forecast. This shows that the economic fundamentals still have strong support for the US dollar index in the third quarter, but the fundamental support will weaken in the fourth quarter.
In addition to the relative performance of the economy, the relative monetary policy outlook is also an important consideration. According to the OECD forecast, except for Japan, major developed economies are likely to raise interest rates during the year, and there is no significant differentiation in monetary policy. From the perspective of OIS interest rates, the market revised its expectations for the Fed to cut interest rates in the second quarter, which led to a rebound in the U.S. dollar index. However, the further upward movement of the U.S. dollar index is insufficient when the Fed does not raise interest rates beyond expectations. In the absence of significant differentiation in fundamentals and monetary policy, it is difficult for the U.S. dollar index to have a trending market, or to fluctuate in a range.
The market generally expects that the net issuance of U.S. Treasury bonds in the third quarter will be at least about 700 billion U.S. dollars, which may trigger tight dollar liquidity. However, the absolute and relative levels of bank reserve balances are still at a relatively high level. At the current speed of shrinking the balance sheet, the relative level of reserve balance/stock U.S. debt will not be close to 2019 until the first quarter of 2024; the reserve balance will still be higher than the 2019 level by mid-2024. Therefore, in the second half of 2023, macro liquidity will continue to maintain a relatively ample level, which is very different from the liquidity environment in 2019 when the US dollar was "money crunched". We believe that the possibility of a dollar liquidity crisis within the year is unlikely, and the centralized issuance of U.S. debt will have limited impact on the U.S. dollar index.
