US Dollar Forecast Q2 2022: Dollar Rate Hikes, Conversion and Safety Appeal

At this point in time, it is impossible to predict what function, if any, the Dollar will play in the global financial system as we approach the second quarter of 2022. On the one hand, conventional risk assets have pushed back the tide of a more widespread collapse, while interest rate expectations have skyrocketed to unprecedented heights. Alternatively, there is rising fear that markets have overreached in the wake of the Great Financial Crisis and that the required 'de-risking' has not yet taken place.

It is vital to determine which topic will take the lead in order to follow the direction of the Greenback throughout the next months. There are certain critical issues that should be considered while making USD estimates, such as the forecasts for the Federal Open Market Committee's interest rates and economic growth. However, traders should not lose sight of the pressure on the benchmark currency to live up to its'systemic haven' status as crises unfold around the world and major economies (such as Russia and China) look for alternatives to the world's principal currency through the scheduled and unscheduled event risk.

DOLLAR: THE SAFE HAVEN

During the first quarter of the year, there were a few of positive fundamental factors that may have contributed to the US currency's rise. Reversal of risk trends is one of the topics that is most closely associated with one another. During most of the first quarter of the year, benchmark speculative assets such as the S&P 500 and the Dow Jones Industrial Average suffered a significant decline, with investors increasingly seeking safety. The degree of anxiety often counts for the dollar, since more measured swoons tend to cause investors to be more selective in where they plan to deposit their wealth, according to the Federal Reserve.

The currency would be less than ideal as a vehicle for storing money if the returns on US assets were uncompetitive. When liquidity is the sole factor to consider, the USD continues to be a safe haven in my opinion. Despite this, the country's benchmark interest rates have increased in a manner that is uniquely competitive, making it one of the most nuanced safe havens. In light of how adamant Fed officials have been about their deliberate push ahead with accommodation removal, it seems that a charge will be maintained.

CHART 1: DXY INDEX OVERLAID WITH VIX, 12-WEEK CORRELATION AND US 2-YR YIELD (WEEKLY)

RATE EXPECTATIONS OUTSTRIPPING OR KEEPING PACE?

Interest rate expectations are yet another important fundamental subject to keep an eye on in order to comprehend the Dollar's intentions in the next months.. Of course, it is critical to maintain a clear line of sight on the US dollar, but the relative hawkishness or dovishness of the US course necessitates a comparison with the global course of other countries. The Federal Reserve was able to feed an extraordinarily aggressive prediction into the second quarter of the year as the year came to a close.

In response to the first rate hike in March, the Federal Reserve increased its own rate forecasts from the three projected in the December SEP (Summary of Economic Projections) to a whopping seven hikes through the end of the year – at every meeting except for one in January, which was held in December. As a result, we found ourselves in an unprecedented situation in which the leading and speculative market was in sync with the trailing and conservative Federal Reserve. However, that coincidental event would not persist long.

CHART 2: RELATIVE MONETARY POLICY STANCE

A total of two monetary policy meetings and announcements are planned during the next three months: on May 4th and on June 15th, respectively. Beginning in early April, Fed Fund futures and swaps were pricing in high odds (over 60%) of a 50 basis point rate rise from the group at both gatherings, according to market participants. That would be a very aggressive posture to take. It has the potential to be a substantial boost for relative value as well. While the Fed is currently lagging behind some of its rivals in terms of primary rates of return, rapid raises may swiftly bridge the gap – and the markets are forward-looking in terms of analysis and pricing – in the short term. For those who have come to really believe in the 'central bank put,' the US authorities have gone to extraordinary lengths to suppress that previously merited trust in the first place.

Why would they do anything like that? They are attempting to break free from a dependence. And the markets have taken their warnings seriously. We have witnessed the most aggressive near-term hawkish rate expectations in more than two decades when we look at Fed Funds futures contracts.

CHART 3: DXY DOLLAR INDEX RELATIVE TO IMPLIED FED FUNDS YIELD OF NEXT MEETING

THE OUTLIER RISK FOR THE DOLLAR: DIVERSIFICATION

To assess the fundamental current, the Dollar will very certainly look to its own interest rate expectations compared to equivalents or the condition of market sentiment to make its decision. Correlations, on the other hand, might fluctuate in response to changes in systemic linkages. Over the previous quarters and years, one of the outlying items that I have been keeping an eye on with caution has been the drive to diversify away from the world's most liquid currency, the US dollar. The previous administration's quest for trade wars was considerably more widespread and severe, but the current situation seems to have solidified the Dollar's ability to fulfill its previously declared goal.

Having said that, there are a number of significant nations who are very driven to see the globe move away from the USD. Because of its attempts to bypass Western sanctions, Russia was the most agitated alternative seeker over the most recent three months. China has emerged as the major force seeking to weaken the influence of the United States and its currency. The world's second-largest nation has long had ambitions to get to the top of the rankings and have a more significant impact on the global order. Given the ongoing troubles with Covid, trade partners' responses to Russian sanctions, and overleveraged domestic companies, there is more motivation to promote the Yuan as a Dollar rival. It is unlikely that this will pose a severe danger for some time, but it has the potential to substantially upset tendencies that have emerged as a result of erroneous conviction.