Vivek and Hari Kishan

BENGALURU, (Reuters) – Most currencies won’t be able to gain against the U.S. Dollar in the coming months as the Federal Reserve expects to tighten monetary policy, providing the greenback enough fuel to continue its dominant position well into 2022. Analysts said.

Nearly half of the 49 foreign currency strategists polled in Reuters’ Jan. 4-6 survey said that interest rate differentials will dictate sentiment in FX markets for the near future, while only two were concerned about new coronavirus varieties.

A large majority of the analysts polled believed that volatility in foreign exchange markets will increase over three months. Well above 80% said so for majors as well as EM currencies.

The Fed is expected to increase interest rates in March, and then begin reducing asset holdings shortly afterward. This will give the dollar an advantage over major currencies.

The U.S. is expected to raise interest rates at least 3 times this year, according to financial markets.

Kerry Craig, JP Morgan Asset Management’s global market strategist, stated that there has been an increase in U.S. Dollar strength over the past few months, driven mainly by widening interest rates differentials and the inflation dynamics within the U.S. relative other major markets such as Japan and Europe.

He said that the Fed was becoming more hawkish, and responding to this by tapering earlier than expected a few months back… (and soon), start raising rates should support dollar over first half of year.” (Graphic: Reuters Poll: Outlook for major currencies, https://fingfx.thomsonreuters.com/gfx/polling/znpnelkxrvl/Reuters%20poll%20-%20%20Outlook%20for%20major%20currencies.PNG)

Analysts don’t expect major currencies and emerging currencies will make significant gains against the greenback over that time period, according to median forecasts.

The dollar’s dominant position is not universal. However, in the past Fed tightening cycles emerging market currencies were likely to feel the effects most.

Kamakshyatrivedi, global FX rates and EM strategist at Goldman Sachs, stated that the macro environment is challenging for emerging markets assets.

“Growth slows from peak rates as world reopening boost fades, monetary tightening underway, China has shifted in a lower gear for growth, while some old-school EM concerns like inflation fiscal overreach or political instability are still on the table.” (Graphic: Reuters Poll: Major currency market outlook, https://fingfx.thomsonreuters.com/gfx/polling/zgpomakawpd/Reuters%20Poll%20-%20Major%20currency%20market%20outlook.png)

One of the emerging currencies that was polled predicted a depreciation rate between 2% and 6.5 dollars per dollar over a one-year period. It was also predicted that the Philippine peso would weaken by 1%, Malaysian Ringgit, and Indian Rue will cling to an average range.

Turkey’s battered lira, which plunged 44% in 2021 to reach its lowest point since the 2002 election of President Tayyip Erdogan and his AK Party took power in 2002, was expected to lose 14% more this year. That would make it one of the poorest performers in emerging markets.

The Yen, which is another high yielder, will continue to trade rangebound over the next six months, falling 0.4% to 15.78/$ annually.

It was also unlikely that major currencies would be able to recover their losses of 2021 over the following 12 months.

After losing nearly 7% in 2017, the euro was expected to rise slightly below 1.5% by 2022. Japan’s yen would trade at current levels, while the Swiss franc was forecast to fall by 3% within a year.

Although the trend seems to favor the dollar strengthening across all markets as more information is available on Fed policy, experts warn that there are still many risks.

Jonas Goltermann is a senior market economist at Capital Economics. “Given how uncertain economies will evolve and the response of policymakers, we feel more confident that currency volatility (will be) relatively high,” he said.