The U.S dollar strength has waned a little over the past month, or so, but it is clear once again that you can’t keep a good currency down.

The U.S dollar strength has waned a little over the past month, or so, but it is clear once again that you can’t keep a good currency down. This being said, we would not necessarily argue that the US dollar is a “good” currency; more like it is on top because the global macroeconomic backdrop is so difficult that traders and investors are putting a high premium on safety.

For when you think about it, the US has fallen into a technical recession with two quarters of negative growth. No other developed country has done the same. At the same time, inflation has shot up and the Fed is hopelessly behind the curve with its rate hikes. Another issue is that trade data has deteriorated significantly. When we put all these things together it is clearly not a recipe for currency strength in a traditional sense. But the global economic environment is anything but traditional with stagflation pressures the worst we’ve seen in over forty years.

The bulk of these pressures are coming from higher energy and food prices with gas prices a particular concern in Europe. Prices here continue to soar and it seems that every increase just tightens the screw on European currencies relative to the dollar. The euro and sterling are particularly sensitive. It seems clear that the earlier foray below parity for euro/dollar was not the low in this cycle as we can expect a more significant slide as the gas-price screw tightens over the winter period.

The same is true for the pound. Indeed, things could become a lot more uncomfortable yet for these currencies. To date, we’ve only seen the inflationary consequences of the surge in gas prices, which are bad enough. But as we move into the autumn and winter, the spectre of power shortages starts to rise and this could add a whole new impetus to dollar strength against the euro and the pound.

Up to now we’ve tended to argue that euro/dollar will bottom out in the 0.95-1.0 range with sterling down to the 1.15-1.20 region. So far, this is playing out but we don’t doubt that the bottom could really fall out of these currencies if the inflationary difficulties of surging gas prices are compounded by power cuts.

What will it take for things to turn around and the dollar to cede significant ground to the euro, pound and other currencies? For a start, it would appear to require some stability and turnaround in European gas prices; something that may only happen when the conflict in Ukraine concludes; something that could still take many months, if not years. It would also appear to require some turnaround in the global economy, with recession turning to expansion. But here too, we’ve not even fallen into the – very likely – recession in Europe, let alone started the recovery.

A third requirement seems to be a change in expectations regarding Fed policy but, here too, the Fed is still a long way from the peak in the fed funds target, let alone at the start of guidance towards future easing. When we put all these things together, it seems to us that there’s not much scope for the dollar to weaken through the rest of this year and possibly some way into 2023. That’s the reason why our six-month euro/dollar forecast is still as low as the parity level with a recovery only likely thereafter towards 1.10 in a year’s time.

The pound looks to be in the same deep hole as the euro. In fact, it may even be worse as soaring inflation has led to an ugly rise in worker militancy which threatens to hamper growth and damage the UK’s standing in the eyes of overseas investors. The latest strike concern is in the port of Felixstowe where an eight-day strike has started in a port that handles almost a half of container shipments. Fears that this could exacerbate supply chain difficulties and lift inflation still further abound and seem likely to weigh on sterling. Things might not be so bad if the government were seen to be on top of the unfolding crises in labour relations and cost of living pressures. But the government is rudderless until a new PM is chosen on September 5th. It all makes for a dangerous cocktail for sterling with a deeper slide in trade-weighted terms only prevented by the fact that the euro seems equally vulnerable.