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The Macro Brief – The dollar bubble inflates

Paul Mackel, Global Head of FX Research, explains why we think the US dollar has scope to strengthen even further and what it means for other G10 currencies.

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Duration:: 11m
Broadcast on:: 05 Jan 2025
Audio Format:: other

Welcome to HSBC Global Viewpoint. The podcast series that brings together business leaders and industry experts to explore the latest global insights, trends and opportunities. Make sure you're subscribed to stay up to date with new episodes. Thanks for listening and now on to today's show. This podcast was recorded for publication on the 28th of November 2024 by HSBC Global Research, or the disclosures and disclaimers associated with it must be viewed on the link attached to your media player. Don't forget that you can follow us wherever you get your podcasts, including Apple and Spotify, just search for the macro brief. Hello I'm Piers Butler. Now here at HSBC Global Research we've believed in the strong dollar for some time. And while that has broadly played out, is there room for the dollar to strengthen even further? That's what we're discussing on today's macro brief, and I'm joined in the studio by Paul Mackel, though we'll head of FX research. Paul, welcome. Thank you very much. In fact, that strong dollar view has been held since what is it, September 2023? If I'm right. And it's fair to say that the latest developments in the US have reinforced that view and you and your team have revised a number of your forecasts for 2025. So maybe let's start by summarizing those. Well, that's right. I mean, we have been believers in the strong dollar for quite some time. As you mentioned, it's not been the easiest view to hold onto because certainly there have been moments over the last year plus that we've been pushed off side. But you're right. In light of the recent US political developments, we think that the ingredients are still falling into a place for a strong dollar through 2025. So it's about making the dollar even greater again. So what are some of the forecast changes that we've been thinking about? We do see your dollar heading below parity, reaching 0.99 as we roll into the third quarter. We see some depreciation pressures for the remimbi. So dollar C and Y going up to 7.4 by the end of 2025. And also some sterling weakness materializing in the months to come. So cable, sterling dollar, getting down to 1.23. So if we look back at President-elect Trump's previous term in office, not everything during that time was dollar positive. Is there a risk that the markets have gotten ahead of themselves, particularly as concerns the euro? Well, it's a big source of debate, no question, because you're right. In 2017, the first year of his administration, the dollar really struggled. But then it was a very interesting environment for the global economy. It was in the midst of a strong cyclical upturn and that trumped Trump. So in other words, that was weighing on the dollar in many different avenues. But I think right now the context is very different as we're going into 2025. There are many dark clouds for the global economy. We're thinking about conditions in China, also within the Eurozone. And we're thinking about how the US is still looking rather exceptional to many other places. And that feeds into, again, our strong dollar view. Now, since you published your latest currency outlook, Scott Besant has been appointed as the treasury secretary for the US. Is that dollar positive? He talks about the dollar's smile. What does that mean? Yeah, there's been a lot of fixation with his comments in recent months about whether he likes the dollar or does he think the dollar should be weaker. If anything, the more recent indication suggests that it's sticking to the party script that the market or the dollar should be market determined. That is, if US economic conditions or global economic conditions warrant a strong dollar, then so be it. And the opposite holds true. I don't think that we can just grab onto one scenario and thinking that he wants one side of the dollar to be stronger or weaker. It's not quite like that. This week there were some proposed tariff announcements that hit the price. How did the currency markets react? And more broadly, how do we see the differences between now and the 2018 tariff shock? Well, it's a good question, we did see a knee-jerk reaction by the currencies that are in the frame, such as the Canadian dollar, the Mexican peso, euro, the renminbi. They all weakened versus the dollar. And it's made market participants come to think that this is where the spotlight could be as the Trump administration comes into being in January of next year. But that said, with the difference between now and where we were in 2018, it's less of a surprise. I mean, tariffs have been rising in different ways over the years. And we're also pretty much in tune with how the Trump administration has been viewing tariffs again for quite a lengthy period. So the shock value isn't so shocking as what I'm trying to say. Yeah, no, I think that's fair. On China, there seems to be some contrasting forces. On the one hand, the market appears to have been disappointed over the measures to support the property market and consumption. On the other hand, there was a positive reaction to the announcements regarding local government debt swaps and how they will benefit the real economy. So how does that affect your outlook on the renminbi? Altogether, I'd say that the fact that Chinese authorities have been pushing forward with policy stimuli should be seen as a net positive for the currency. So it's about stabilizing growth rather than where we were a few months ago, where growth concerns were more heightened. But that said, in an environment of a strong dollar, the risk of tariff policies being imposed, we do believe that depreciation pressure for the renminbi will continue in the quarters to come. We don't think it's going to be very aggressive. We think that China's authorities still have a preference for basically stable currency, but in a strong dollar world, it's going to be very difficult for the renminbi to fully withstand that force. What about the yen? You revised your dollar yen forecast, but with a word of caution, re-intervention by the monetary authorities, we know they have interviewed previously on the yen weakness. At what level did they exchange it, do you think that that risk becomes quite high? It's always hard to tell where the pressure point exists for Japan's authorities. But I think in the eyes of the market, that probably exists where they were last intervening or showing a stronger hand. And for the exchange rate, that is dollar yen, that was around $160. So we're making that assumption. If the exchange rate is drifting higher towards $160, then that intervention threat begins to rise materially. So yes, in a strong dollar world of Japanese yen, we'll probably also struggle marginally, but we have to take into account that Japan's authorities to be quite committed in stabilizing the currency if speculative forces get too strong. Let's finish on sterling. Where do we stand with that currency? I mean, is it sort of not as affected as a euro, but nevertheless still some concerns? Well, there's multiple angles there, frankly. First of all, sterling yields, as we know, are on the higher side than a number of other currencies, which provides somewhat of a buffer. The second thing is it's not going to be caught in the same tariff spotlight as the euro or some other currencies in the emerging world, that's helpful. The other thing that we have to bear in mind, which could become more thematic in 2025, is how does the UK government approach ties with the rest of Europe? Is it warmer? If that's the case, then the FX market could treat it also more positively for the British pound. So we think it's probably the best of a less hopeful bunch at this juncture amongst the European context, that is, we like sterling versus many European currencies. A little curveball just to finish on. Following the Fed is obviously a key part of any FX strategist's occupation in terms of working out what's going to happen to the currency. And your colleague Mark McDonald, who heads are data science and analytics researchers, just published a report looking at whether AI can follow the Fed. Are you worried? Short answer is no. Not yet. Thankfully, I think we still got a good long runway in front of us before we can all be replaced by AI. That said, it's a very interesting tool, the findings, and it's showing some similarities to how humans track the Fed and the outcomes. Is it hawkish or is it dovish? But what it also means is that as this technology becomes a lot more advanced, and the ability to follow not only what the Fed is doing and other central banks in a very quick-fire manner, translating what that could mean into the currency market, it could be a tool that helps actually suppress volatility because markets become faster at, as I said, deciphering the statements in the language. So it's going to be very interesting how this plays out in the years to come. But as I said, I still think we've got a long runway in front of us. Thank you. Paul, on that note, thank you very much for joining us today. Thank you very much. That was Paul Mackel, our global head of FX research. And if you'd like more detail on how a strong dollar could affect Asian currencies, then please take a listen to the latest edition of our sister podcast, Under the Banyan Tree, which this week features JHU, our head of Asian FX research. Now before we go, here are three quick highlights from global research this week. Industrial analysts Sean McLaughlin and Jonathan Day have just published their latest insights into global capital expenditure trends. They now see CapEx spend of above 6% this year, slowing to around 2% in 2025. Crucially though, technology CapEx accounts for an increasing proportion of the top 10 spenders, with the all sector falling in relevance. And as we mentioned earlier, an interesting experiment from our data science team. They've pitted their new AI model against our US economist Ryan Wang to find out who is better at analyzing Fed speeches. The conclusion? Well, while they find that the AI system does a fairly accurate job, the real issue is the lack of consistency to its answers, meaning it can't be used as a trusted advisor. Consequently, Ryan isn't worried that AI is coming for his job just yet. And finally, a reminder that the Excel Asia Survey 2025 is underway. If you are an HSBC client participating in this survey and you value our service and insight, then please vote. The survey is already open and runs until the 6th of December. That's it from us. Don't forget that you can contact us at arseresearch@hspc.com. And if you haven't done so already, please follow the macro brief on Apple and Spotify or wherever you get your podcasts. Thanks for listening and we'll be back next week. Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes. [MUSIC PLAYING]