Tighter Fed policy to end USD window of weakness – ING

April saw the dollar hand back nearly three-quarters of the gains it made in the first quarter of 2021. As long as the Fed feels comfortable allowing the economy to run hot – and delaying its normalisation cycle – economists at ING think the dollar has a window to stay offered.

A limited window for dollar weakness

“Window for dollar weakening against European FX looks limited. Currently, we would say it is a nine-to-twelve-month window. Yet this window would snap shut were the Fed to conclude that monetary normalisation should take place earlier than currently priced. The risks certainly seem to lie in that direction, but for the time being the Fed seems to be holding the line and trying to ride out the spike in US activity and prices.”

“In the event of a hawkish surprise from the Fed and presumably bearish flattening of the US curve, we would have to reappraise our core 2021 view of a benign decline in the dollar. 

“An early withdrawal of the Fed’s punchbowl could certainly prompt some market dislocation and dollar strength against the G10 FX commodity complex and emerging market currencies in general.”

“EUR/USD is set to benefit from the European recovery story in the second half of 2021 and we retain a scenario of a move to the 1.25/28 region later this year. Such a move would be helped by continued progress on the EU Recovery Fund and perhaps also by the progress of the Greens in the opinion polls ahead of September elections in Germany.”