Five factors suggest the Dollar may be at the beginning of a cycle of depreciation – JP Morgan

From September 2022 to January, the Dollar weakened by over 6%. Where will the USD go from here? Economists at JP Morgan expect to see a cycle of Dollar weakness.

Expensive starting point vs. fair value

“After ten years of strength, the Dollar is close to its highest level since 2001 and expensive versus long-term variables that define its ‘fair value’, such as the current account.”

Widening growth differentials

From 2012-2022, the rest of the world only grew 0.5% more than the US, a stark difference versus the 2.3% from 2001-2011. This gap is set to widen again in favor of the rest of the world to 1.2% over the next five years. This year’s positive upgrades to growth in Europe and China versus rising probabilities of a US recession is a move in that direction.”

Shrinking interest rate differentials

“By October, US 10-year yields were 2.2% higher than other developed markets. Since then, yield differentials shrank to 1.7% as other central banks joined the tightening trend. This gap is set to shrink further should the Fed pause and soon start cutting rates, as seems more likely after the regional banking stress.”

Flows returning to non-US markets 

“Over the past decade, due to US economic and earnings resilience and higher interest rates, global capital flocked to US markets. However, we seem to be at the beginning of a turnaround given the change in the international growth and interest rate backdrop, together with a potential shift in market leadership.”

Sentiment is key short-term

“During risk-off moments, a flight to US safe-haven assets can overwhelm other variables. Since the regional banking stress began, bond volatility has surged. A short-term period of Dollar strength versus emerging markets currencies may follow.”