US Dollar to Stay Stronger for Longer As Fed Hikes Rates to Tame Inflation

  • The US dollar is set to stay “stronger for longer” while the Fed continues to hike rates, according to UBS.
  • The Russia-Ukraine war and ongoing volatility in the British pound means the dollar will continue its climb, UBS said.
  • “Concerns over UK debt sustainability look set to keep sterling under pressure,” UBS said.

The US dollar is the best positioned currency to continue its rise against other currencies like the British pound and the euro, according to a Monday note from UBS.

The bank said the dollar will stay “stronger for longer” as long as the Federal Reserve remains committed to taming inflation via more interest rate hikes despite the risk of a recession. The Fed raised rates by 75 basis points last week and its updated dot plot suggests more rate hikes will arrive into early 2023.

That, combined with a questionable move by the UK government to slash taxes despite hot inflation, means the DXY dollar index likely won’t top out until early 2023, according to the note.

“With markets repricing a higher federal funds terminal rate amid broad risk-off sentiment, we believe the dollar is set to be stronger for longer over the next six months,” UBS said. The DXY dollar index is up 18% year-to-date, with gains accelerating in recent days.

On Friday, the US dollar surged almost 2%, and those gains extended to more than a half percentage point on Monday.

Setting up the dollar to strengthen further against the euro is the ongoing Russia-Ukraine war, which could once again send energy prices higher and drag down the euro following Russia’s decision to partially mobilize 300,000 reservists.

“We believe this will likely have implications for energy prices and inflation, weighing down the economic outlook for Europe. As a result, we are keeping the euro as least preferred,” UBS said. 

When it comes to the British pound, UK debt sustainability remains top of mind for traders and is likely to keep the pound under pressure. The pound fell to a record low against the dollar over the weekend after the UK’s finance minister doubled down on its fiscal stimulus measures despite the currency moves.

“The reaction reflects concerns that the fiscal package puts Britain’s public finances on an unsustainable trajectory. We view this as a legitimate concern, and we don’t see enough measures in the package that look likely to boost economic growth over the medium term,” UBS said.

“With the global growth outlook uncertain, the US dollar is likely to benefit both from its safe-haven quality and its yield advantage,” UBS concluded.  

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