Nomura analysts in a note dated Tuesday forecast continued weakness in the U.S. dollar, especially in Asian markets. This outlook is driven by several macroeconomic factors, positioning adjustments, and portfolio reallocations, which are expected to put downward pressure on the USD in the coming months.
Nomura anticipates a narrowing of the growth differential between the U.S. and Europe, which has been a significant factor in USD strength.
The U.S. is expected to see its growth outperformance weaken, with the GDP growth gap between the U.S. and the EU forecasted to narrow from 1.6% in Q2 2024 to 0.6% in Q3 2024 and 1.0% in Q4 2024.
“This is likely to support EUR/USD, while our discussions with market participants concluded that there are positioning risks towards a higher EUR/USD if spot breaches recent highs of 1.1139 in December 2023 (and 1.1276 in July 2023; last at 1.1077),” the analysts said.
Significant shifts in speculative positioning are another factor contributing to the anticipated USD weakness. While positioning has been reduced, Nomura analysts believe there is potential for these positions to become short on the USD.
This could be driven by increased portfolio allocation towards Emerging Markets (EM) in Asia, as well as unwinds of USD accumulation by corporates, retail investors, and life insurance companies.
Substantial USD hoarding in Asia, particularly in China, Taiwan, and Korea, may begin to unwind, further pressuring the USD.
Foreign portfolio investments into Asia are expected to increase, driven by a recovery from outflows that began in July 2024. Despite recent net foreign equity outflows in Taiwan and Korea, there are signs of a rebound, which could lead to increased capital inflows into Asian markets.
Real money investors have maintained underweight positions in Asian bonds, and there is potential for reallocation, particularly in markets like Indonesia.
Furthermore, Asia's financial markets are still recovering from the significant outflows experienced during the COVID-19 pandemic, which could further support a weaker US dollar as these markets stabilize.
Historically, the USD has tended to weaken in the period leading up to and following the first Federal Reserve rate cut. With the Fed expected to begin its rate-cutting cycle in September 2024, Nomura anticipates further USD weakness, particularly against Asian currencies.
The past five Fed rate cut cycles have shown that USD/Asia currency pairs weakened by an average of about 2% in the month before and after the first Fed cut. Moreover, most Asian central banks are unlikely to be active in buying USD during the early stages of an Asia FX recovery, given that most Asian currencies remain undervalued according to various valuation metrics.
China’s economic situation remains a critical factor. Nomura suggests that a significant policy package aimed at stabilizing the property market could be introduced by the end of the year, which would likely support further USD weakness.
A more stable Chinese economy could lead to increased confidence in Asian currencies, exacerbating the USD’s decline in the region.
The upcoming U.S. presidential election poses additional risks to the USD. While current polls suggest a potential Democratic win, the uncertainties surrounding a potential Trump victory could lead to USD volatility.
If Trump were to focus on issues such as geopolitical tensions, pressure on the Federal Reserve, and efforts to weaken the USD, there could be further downside for the currency, particularly if these policies are prioritized early in his term.
