G10 major currencies forecast

GBP/USD – EUR/USD and USD/JPY forecast

US default stands in the path to a weaker Dollar

Tighter US credit conditions make a US recession, a deeper Fed easing cycle and a weaker dollar all more likely. I continue, however, to favour the dollar bear trend really taking hold in the second half. Before then I have the small matters of a US banking crisis and a possible US Treasury default. The next couple of months could be volatile for the dollar.

EUR/USD: The bumpy path to a higher EUR/USD

Based on my view that the Fed tightening cycle is over and that a credit crunch makes a US recession more likely, I believe the dollar is about to embark on a multi-quarter (if not multi-year) decline. The bulk of that dollar decline may come in 2H23 as the US disinflation story builds and the Fed front-loads easing with 100bp of cuts in 4Q23. That could see EUR/USD at 1.20 end year.

The path towards a weakening dollar may encounter obstacles along the way. The primary concerns revolve around the impending US banking crisis and the potential for a US Treasury default during the June/July timeframe. It is worth noting that historical trends indicate that stress in US money markets often leads to a temporary surge in the value of the dollar.

Any flash crash below 1.05 should be temporary.

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USD/JPY: 137/140 should be best levels for a while

As a dollar bear, I find the performance of USD/JPY to be consistently disappointing. The risk environment has not deteriorated sufficiently, nor has US disinflation shown significant strength to cause a sharp decline in USD/JPY. However, the current US credit crunch increases the likelihood of a recession, leading me to firmly believe that USD/JPY will experience a substantial decrease in value by the end of this year.

Following new BoJ Governor Kazuo Ueda's initial policy meeting, USD/JPY experienced a rally in Japan. This was attributed to the announcement of an 18-month policy review. However, I believe that there is an underestimated risk that the BoJ might initiate policy normalization during its upcoming meeting on 16 June.

137/140 may be the best levels for the next two to three years.

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GBP/USD: Sterling’s correlation with risk assets declines

Since its lows in September, the Bank of England's trade-weighted sterling index has experienced a notable rally of approximately 9%. This positive trend marks a significant turnaround from the challenging period under the brief Liz Truss government. The weakness observed during that time appeared to be an overshoot, and the current strength of the sterling can be attributed, in part, to asset managers reversing their bearish positions on the currency. Interestingly, this community is currently holding a net long position in sterling futures contracts, a shift that hasn't been seen since 21 October.

Based on my overall dollar view, GBP/USD should be heading higher this year. 1.33 is my target for year-end.

Interestingly, sterling’s correlation with risk assets has fallen a lot this year – a factor probably helping sterling now. Yet we see a less hawkish BoE coming through, limiting GBP gains.

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