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Pound to Dollar Rate 6-Month Forecast: USD Rally is Over but Don’t Expect GBP/USD to Capitalise

US Dollar rally has ended

The US Dollar’s multi-year period of appreciation is over, but beware, it won’t fall in a straight line and the British Pound won't necessarily capitalise on the move lower.

This is according to fresh analysis of the global FX landscape conducted by Societe Generale.

The French investment bank briefs clientsthat the Dollar should embark on a long-term period of depreciation after year's of gains. Indeed, now “the third big US Dollar rally of the post-Bretton Woods era has stalled,” says analyst Kit Juckes at Societe Generale’s London branch.

Dollar rally peaked

Analysis suggests the currency is “significantly overvalued” at current levels, and “a shift in the relative momentum of economic growth and monetary policy from the US to Europe suggests that new highs are unlikely.”

But be warned; the way down will be anything but straight.

“Dollar bears may be frustrated by Fed tightening and a reluctance to tolerate stronger currencies elsewhere. The clearest winner should be the euro, as the ECB can’t normalise policy (even slowly) and expect current valuations to persist, but it won’t like that much,” says Juckes.

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Dollar has Had its Run

After growing at a modest rate of 2.1% in 2012-16, economists at Societe Generale now expect the US economy to slow to 1.7% over 2017-21.

That may be better than the average of the developed economies, and still enough to drag the fed funds rate up towards a neutral level of 2.5%, but it’s not enough to get analysts at the French bank excited about the currency.

The Dollar rallied with gusto through late 2016 as markets rushed to price in US President Donald Trump’s plans for tax cuts and spending increases that were to give a significant boost to the economy and the Dollar.

However, the President has struggled to pass major policy promises; recall the struggle to repeal Obamacare.

For Societe Generale, this suggests that the President’s “political honeymoon is well and truly over, the current account deficit is growing again, and higher rates elsewhere will increasingly compete for global capital flows.”

Juckes says that at best, the Dollar will bump around without falling significantly, but that’s not really what happens in the FX market – after the two previous significant peaks, it fell pretty sharply, by 15% in real terms in the year after the 1985 peak and nearly 5% after the 2002 peak.

Societe Generale’s medium-term central scenario sees a choppy Dollar decline, with EUR/USD peaking at 1.18 by year-end but retracing lower afterwards. However, there are potential scenarios in which EUR/USD goes much higher in 2018.

However, Sterling is not seen strengthening against the Dollar by the same degree as the Euro.

The Pound to Dollar exchange rate is forecast at 1.28 by the end of 2017 and 1.24 by mid-2018.

Other analysts share the idea that the Dollar’s long-term period of appreciation might be coming to an end.

Research by HSBC has resulted in the British bank cutting their forecasts for the US Dollar based on their latest analysis of Donald Trump's economic policies and his administration's effectiveness in achieving them

It's Time to Buy GBP/USD say ING

Analysts at ING Bank N.V. have said too much negative news is incorporated in Sterling following recent political shifts.

The Conservative Party have lost their working majority in the lower house of the UK parliament which has opened the door to significant political uncertainty and the Pound has responded by falling.

However, with an eye on the next steps the currency might take is analyst Viraj Patel at ING, who says now could be the time to prepare for a recovery.

Patel tells clients that, “history may show that one of the lasting effects of the 2017 General Election hung parliament result was a paradigm-shifting change in the UK’s Brexit stance.”

For Patel, the Pound Sterling’s outlook therefore rests with the nature of the Brexit deal that will emerge over the next two years.

“It may be way too early to conclude this with any certainty right now, but the loss of Conservative seats – and rise in Labour foothold – suggests that the dial within the UK parliament may tilt towards a ‘softer’ core Brexit view, with some ‘hard’ Brexit pushback,” says Patel.

ING believe “this subtle change makes long GBP positions look attractive as a lot of bad news seems to be priced into a heavily undervalued GBP.”

Analysts at the bank’s London branch believe that too much bad news is priced into GBP, with the currency now reflecting both (1) a short-term domestic political uncertainty premium and (2) medium-term ‘hard’ Brexit risk premium.

“GBP is undervalued by a significant 15% vs EUR. This is a meaningful undervaluation in both absolute and relative terms and will in our view serve as a cushion against any further pronounced GBP weakness,” says Patel.

Further analysis suggests the current EUR/GBP exchange rate overvaluation is equivalent to a 12% drop in UK labour productivity.

“This looks extreme and should limit GBP downside from here,” says Patel.

Morgan Stanley see USD Recovery

But as always the case in foreign exchange discussion, there are two sides to the strong-Dollar argument.

Recall Societe Generale see the Dollar's multi-year rally fading?

Analyst Hans Redeker at Morgan Stanley has this week told clients that his team now believe USD weakness has gone too far.

“Within six months, markets have swung from being extremely upbeat on the USD to the opposite, but by now USD sentiment and positioning have gone to extreme levels, suggesting that a minor improvement in the fundamental outlook of the USD or a significant equity market decline could spark a significant USD upward reaction,” says Redeker in a briefing dated June 12.

It is the belief of the US investment bank that over recent weeks USD has decoupled from nominal interest rate differentials, suggesting that the importance of debt-related flows has eased relative to equity and other long-term asset flows.

“This is why the equity market evolution is determining the direction of the USD for now,” says Redeker.

Morgan Stanley have turned tactically bullish on USD and see negative sentiment and short positioning as extreme and a modest increase in the outlook could result in a significant USD appreciation.

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