The US dollar could be in for a rough ride over the next 18 months, according to a recent research note by Stephen Jen, the founder of Eurizon SLJ Capital. Jen predicts that the greenback could fall by as much as 15% in the coming four-to-six quarters, as inflation cools and the Federal Reserve (Fed) loosens monetary policy.
Inflation in the US has been a hot topic in recent months, with consumer price index (CPI) reaching a high for the cycle in June 2022 at 9.1% YoY, the highest rate since November 1981. However, Jen believes that this trend will soon reverse, with CPI predicted to drop below 4% by the fourth quarter of 2023.
Jen explained that “we expect US inflation to continue to decline at roughly the same pace as it rose in 2021 and the first half of 2022: historically, there has been scant evidence of downside stickiness in inflation, even if there is evidence of downside price and wage level stickiness.”
Jen’s “dollar smile theory” suggests that the US dollar strengthens when the economy is either strong or weak but weakens when growth stagnates. According to this theory, the US dollar is set to experience a 10-15% depreciation in the coming 18 months, as inflation subsides and the Fed continues to loosen monetary policy.
The Fed has already implemented nine rate hikes, with a 25 basis-point rate hike in March 2023 amid the Silicon Valley Bank crisis. However, the next 250 basis points of adjustments to the federal funds rate are predicted to be cuts, according to Eurizon’s strategists.
The US dollar index, which measures the strength of the greenback against a basket of rival currencies, has already declined 2.46% over the last four weeks, after notching up a 7.9% gain in 2022.
According to Eurizon’s view, the US dollar “is vulnerable to substantial (10-15 percent) depreciation,” and that “fading inflation with a soft landing should push the dollar into the deep trough of the Dollar Smile. This could mean 10 percent generalised dollar depreciation this year, and more next year.”
Overall, while the current state of inflation and monetary policy may be causing concern for the US dollar, only time will tell whether Jen’s predictions prove accurate.
