A key reason for the devaluation of the euro/dollar exchange rate is – apart from the fears surrounding the eurozone economy and the evolution of the energy crisis – and the strength of the American currency. According to UBS, however, although in the current risk-off environment, the dollar’s rally is likely to continue, the currency’s strength is not expected to be sustained in the long term and it estimates that the Swiss franc is now a safer haven.
More specifically, UBS notes that further upside for the US dollar is likely to be limited by slowing US economic growth and market perceptions that the Fed will start cutting interest rates again in 2023. Concern over the growth outlook prompted investors to trim expectations for Fed tightening in 2022 from around 355 basis points in mid-June to 335 basis points currently. Futures now suggest the Fed should start cutting interest rates again around May next year to support growth. This is a less supportive backdrop for the US currency in the medium to long term, UBS argues.
In fact, according to the bank, the Swiss franc now looks more attractive than the US dollar as a safe haven, especially given the central bank’s willingness to allow the currency to appreciate to curb inflation. The Swiss National Bank’s (SNB) surprise rate hike of 50 basis points in June was seen as an early first step in tightening, especially given that inflation was slightly below 3%. Even with inflation at 3.4% in June, the highest rate since 1993, price pressures remain modest relative to other parts of Europe and the US. Meanwhile, the SNB has shown a greater willingness to allow the franc to rise in order to contain inflation. This combination helps explain why the franc is only slightly below the dollar while still worth more than the euro for the first time since a brief rally in 2015.
In addition, UBS estimates that commodity-linked currencies are also expected to appreciate, particularly the Canadian and Australian dollars, as the recent period of commodity weakness reverses. The price of Brent came under fresh pressure last week, falling from above $114 a barrel to around $107 on Monday, reflecting concerns about slowing global growth. “We expect this move to reverse as OPEC+ tries to meet production quotas and if future Covid restrictions in China turn out to be less severe than expected,” he notes.
Also, recent economic data highlighted the strength of both the Canadian and Australian economies. In Australia, domestic credit, housing starts and retail sales have all surprised positively recently. Canada’s GDP grew at a steady annual rate of 3.1% in the first quarter, while retail sales beat expectations in May. “As a result, we expect the central banks of both countries to remain on a tightening path, which, together with the expected renewed rally in commodities, should support their respective currencies,” UBS said.
Therefore, as the Swiss bank concludes, “we advise investors not to position themselves for a sustained continuation of the US dollar rally. Instead, our preferred safe-haven currency is the Swiss franc. We also favor commodity currencies, which we expect to benefit as commodity prices recover from recent declines”.