Brace for an extended period of dollar weakness as the US economy is set to slow and the Fed will end rate hikes, HSBC says

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Brace for an extended period of dollar weakness as the US economy is set to slow and the Fed will end rate hikes, HSBC says
It's likely there'll be pain ahead for both the US dollar and the economy as the Federal Reserve winds down its interest-rate hikes, HSBC said Wednesday.Andrew Burton/Getty Images
  • Investors should prepare for at least six months of dollar weakness, according to HSBC.
  • Strategists warned that stagnating US growth and the end of the Federal Reserve's rate-hiking campaign will both weigh on the greenback.
  • "Slowing US growth and peak rates should cause the US dollar to start trending down again," they said.
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Investors should prepare for a period of US dollar weakness from the middle of this year onward, according to HSBC Global Private Banking.

The greenback will likely be dragged lower by an economic slowdown in the US and the Federal Reserve winding down its campaign of interest-rate increases in the second half of 2023, strategists said in a research note published Wednesday.

"Slowing US growth and peak rates should cause the US dollar to start trending down again," a team led by the London-based bank's CIO for private banking Willem Sels said, adding that they expect to see most of those declines between the start of the third quarter and the end of the year.

The US Dollar Index, which tracks the greenback's strength against a basket of six other currencies including the euro and the Japanese yen, has slipped less than 1% year-to-date, which Sels' team described as being "more resilient than expected".

But they're expecting the US currency to struggle from July onward due to the Fed potentially pausing its rate hikes – and the US economy starting to feel the full impact of its tightening campaign. The US central bank has boosted borrowing costs by 475 basis points over the past year to curb inflation.

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Over 50% of traders expect the central bank to hold rates at their current level of around 5% when it next meets on May 3, according to CME Group's Fedwatch tool.

Many investors have pared their bets for further rate hikes since the collapse of SVB Financial earlier this month fueled turmoil in the US's regional banking sector.

That's likely to weigh on the dollar because when interest rates stay at the same level, the currency becomes less attractive to foreign traders who are seeking higher yields.

HSBC also expects US economic growth to flatten over the rest of 2023 as the economy starts to feel the full effect of the Fed's rate hikes over the past 12 months.

That weakness could also drag on the dollar, which is often seen as a reflection of investors' confidence in the US economy.

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"In the short term, lingering inflation pressures may keep the focus on the hawkish Fed tone, though the recent turmoil in the US banking and IT sector has reduced the number of hikes the market is expecting from here," Sels' team said.

"In the long run, the large cumulative policy tightening and the impact of increased uncertainty on business sentiment should compress US growth, and we think that it will become more difficult for the US economy to continue to outperform other Western economies," they added.

Read more: House prices are still very high – so hold off on buying as the US economy will keep struggling, Yale economist Robert Shiller says

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