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Dollar to Win in Event of an U.S. Recession: HSBC

  • Odds of U.S. recession rises
  • But this is USD supportive says HSBC
  • See narrow path to broader USD weakness
  • Could pressure GBP/USD back to 2022 lows

U.S. recession and the Dollar

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The Pound to Dollar exchange rate (GBP/USD) could be poised to resume a long running downtrend following a period of respite in May, with HSBC saying in a new research note there are limited routes to meaningful U.S. Dollar weakness.

Daragh Maher, Head of Research for the Americas at HSBC, says his team's research suggests the stars remain aligned for ongoing U.S. Dollar strength as global and U.S. economic growth continues to slow.

The assessment comes as investors consider the implications for the U.S. Dollar in the event the U.S. economy falls into a recession.

The probability of a recession over the next 12 months is now 30%, the highest since 2020, according to the latest Bloomberg monthly survey of economists. That's up slightly from 27.5% in April.

Macro Hive's recession model that uses the 2s10s curve as input is now assigning a 43% chance of a U.S. recession within the next twelve months.

Increased expectations for a U.S. recession come during a fallow period of performance for the U.S. Dollar that has seen it give back value to the Euro, Pound and other major currencies during the course of May.

But Maher says this is likely a mere pause in the broader U.S. Dollar rally as a U.S. recession would in fact prove supportive of the U.S. Dollar

"If the market is concerned about the tail risks of a possible US recession, it should be buying the USD, not selling it. In most instances, this is backed up by the performance of the USD during peak-to-trough economic cycles in the US," says Maher.

USDperformance around recessions

Above: "USD performance during US recessions"

The findings come amidst a renewed bout of U.S. Dollar buying that analysts say is linked to ongoing market fears that central bank interest rate hikes will continue to slow global economic growth, ultimately increasing demand for the 'safe haven' U.S. Dollar.

"When the global economy is slowing meaningfully, the USD strengthens. Clearly, this relates to the USD’s safe haven status," says Daragh Maher, Head of Research, Americas, at HSBC.

The Pound-Dollar exchange rate had been as low as 1.2156 by mid-May before recovering back to 1.2660 by the turn of the month.

June has meanwhile seen a reversal in fortunes for Sterling as GBP/USD fades back to 1.25 and raises questions if the recent rally is a mere blip in an entrenched move lower. (Set your free FX rate alert here).

"A fresh tailwind blew the U.S. dollar index to two-week highs while it charged to 20-year peaks against the yen. The buck also outperformed against the euro and Canadian dollar, with sterling flirting with 3-week lows," says Joe Manimbo, Senior Market Analyst at Western Union Business Solutions.

Manimbo says the catalyst for the Dollar’s latest surge stems from higher Treasury yields with the 10-year back above 3%, the highest in nearly a month.

"Choppy price action continues to dominate markets as investors weigh the impact of central bank policy tightening on inflation and economic growth," says Fawad Razaqzada, Market Analyst at City Index. "While some indices have bounced off their lows again, the overall price action continues to remain choppy and inside larger downward trends for many."

Razaqzada says we are still in a bear market and with central banks ending quantitative easing and reducing their balance sheets, the good days of the stock markets may well be behind us.

These conditions are likely to prove supportive of the U.S. Dollar going forward says HSBC's Maher.

"The US economy is not alone in facing a growth challenge, one driven by a combination of a real income squeeze and central bank efforts to realign demand lower to match supply. The currency market is not facing just a US slowdown, but a global one, a distinction which history suggests results in a stronger not weaker USD," he says.

Global central bankers are racing to raise interest rates in the face of surging inflation levels, but economists warn that hiking the cost of borrowing will only weigh on economic growth.

"The risk is that policymakers mis-step and either let inflation run too hot and are forced to tighten more thereafter, or tighten over-zealously and prompt a recession. Again, the likely outcome would be a stronger USD," says Maher.

But what would it take to meaningfully turn the tide against the Dollar?

"While there are many routes to a stronger USD, the single path to USD weakness is a narrow
one," says Maher.

He explains this path requires "a brave assumption that the US economy slows enough to temper Fed hikes but not so much as to induce a US recession, and that all of this happens while somehow the rest of the world delivers better economic outcomes."

"It is not an impossible path, but we suspect it is not the most likely," he says.