Alert! Why The US Dollar Is Doomed In 2016!

The US Dollar rallied sharply in anticipation of the first Fed hike, and we believe the hiking cycle is fully priced in. Given we also think the ECB and BoJ have reached the limits of QE, we see USD weakness in 2016.

That’s the non-consensus view from HSBC’s FX strategy team, led by David Bloom, who believe that the USD dollar rally will not only stall in 2016 but that there “are grounds to anticipate weakness”.

The premise of their call is based off three key factors: the US Federal Reserve’s rate tightening cycle will weaken the USD, not support it, that the ECB’s power to engineer further euro weakness is low and that the Bank of Japan is unlikely to expand its QE program further in the year ahead.

Here’s the reasoning behind each of their calls.

1) The Fed tightening cycle will see the USD weaken not strengthen. History shows the USD weakens once the Fed starts to hike rates. In addition, we believe the conversation about the pace of Fed hikes will retain a very dovish tone in 2016, mirroring the experience of other central banks which have tried to raise rates after the 2008/09 financial crisis.

2) The ECB’s power to engineer a weaker EUR is low. The ECB faces constraints on how much further it can expand QE, both in terms of the amount of bonds available to buy, and internal support for further monetary easing.

3) The BoJ is unlikely to expand QE further in 2016. Like the ECB, the BoJ’s QE programme is reaching its limit, and we believe the central bank will move to a rates-based policy framework in 2016. In any event, the pressure for additional easing is on the wane given the BoJ’s focus on the new (and higher) core inflation measure.

While all three will no doubt create debate among market participants, perhaps the most controversial call is that further rate hikes in the US will not support the US dollar.

Analysts at HSBC suggest that history, monetary policy divergence being already factored in, a likely scaling back of rate tightening expectations from FOMC officials and recent data weakness will keep the US dollar on the defensive in the year ahead.

As for the first reason – history – the chart below from HSBC certainly demonstrates that the US dollar has tended to under perform in the period following the first rate increase of a tightening cycle.

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