FX Landscape in Q2, 2024: Navigating the Central Bank Easing Cycle

We expect the US dollar to start declining against other major currencies soon. The Federal Reserve seems committed to cutting interest rates, and seasonal factors tend to weaken the dollar from April onwards. If inflation data cools enough to allow the Fed to begin cutting rates in June as we anticipate, we can expect currencies linked to commodities like the Australian dollar and Canadian dollar to rise meaningfully against the greenback, and even the Japanese yen may rally strongly.

Through the early months of 2024, economic data showed relatively strong growth and stubbornly high inflation. However, we think the forex market should now shift its focus to the coming Fed rate cut cycle. The Fed has made it reasonably clear that it wants to lower rates, and it would take very robust economic figures to derail those plans.

This likely sets up a broad downtrend for the US dollar over the coming months. As we discussed previously, the dollar's price action in November and December 2023 may have previewed what's ahead in 2024 - a steeper US yield curve, a gradual dollar decline, outperformance from commodity currencies, and perhaps even the Japanese yen leading gains as it reverses years of undervaluation versus other currencies.

Market consensus forecasts the EUR/USD exchange rate at around 1.10 by year-end. However, it’s likely that levels in the 1.14/1.15 area as good targets. Why? Interest rate differentials shift to favor the euro and global growth prospects. After the Swiss National Bank kicked off rate cuts in Western Europe, we expect the European Central Bank and Bank of England to follow with their own easing cycles starting in June and August respectively. While these rate cuts should slow - not reverse - the rallies in EUR/USD and GBP/USD, we still see the Norwegian krone as an outperformer.

In summary, we anticipate a weaker US dollar environment emerging over 2024, buoyed by Fed easing and commodities/higher-yielding currencies outperforming, especially against a backdrop of resilient global growth.

The forex landscape looks set for some major shifts in 2024 as central banks around the world pivot toward easier monetary policy. Let's break down some of the key currency pair outlooks:

USD/JPY:

The Bank of Japan has finally raised rates from negative territory to the 0-0.1% range.

While this move saw USD/JPY rally initially on expectations that policy would remain accommodative, I believe the pair will struggle to break above the 152 level. The softer US dollar environment coupled with the fact that the BOJ has now started tightening will make it tougher for USD/JPY to push higher. Local reports indicate the BOJ may intervene if USD/JPY trades up to 155. Looking back, USD/JPY declined last November/December even just on changes to the US rate outlook alone. With the yen still undervalued, we see downside risks for USD/JPY.

GBP/USD:

Economic data in the UK has been improving modestly, aided by tax cuts, setting the stage for the Bank of England to embark on an easing cycle later this year. At its recent meeting, two policymakers dropped their calls for further rate hikes. We expect more MPC members to join the camp for lower rates at the May and June meetings as inflation, especially in services, continues decelerating. Our base case is for four BOE rate cuts starting in August. While the softer dollar trend should put a bid under cable in the 1.28-1.30 area, significant gains beyond 1.30 may prove difficult.

EUR/JPY:

This cross remains elevated as traders position for a gradual pace of BOJ tightening.

However, our view is that conditions could repeat like late 2023 when the yen outperformed the euro as markets braced for lower US rates. Recent reports speculate the BOJ could deliver another hike as soon as July or October, finally putting some tightening premium in the yen. On the euro side, key wage data due in late April will help determine if the ECB can kick off an easing cycle in June as we expect. Overall, we favor yen outperformance and see risks of EUR/JPY softening from current levels.

EUR/CHF:

In a surprise move, the Swiss National Bank cut rates by 25bps to 1.50% in March on lowered inflation forecasts.

The SNB cited the stronger real trade-weighted Swiss franc as a key factor weighing on prices and activity. With the door open for another SNB cut in June, the dovish policy stance combined with aggressive ECB pricing could lift EUR/CHF toward parity in the coming months. Notably, the SNB stated it will be active on both sides of the FX market - data in late June may show them turning into franc buyers.

USD/CAD:

The Canadian dollar looks less appealing relative to other commodity currencies at the moment.

Bank of Canada rate forecasts remain tightly intertwined with Fed pricing, leaving domestic developments with minimal loonie impact so far. Markets are pricing around 80bps of cuts for both the Fed and BoC by year-end. However, Canadian inflation has undershot for two straight months, and the BoC stance is distinctly more dovish now. We anticipate the first BoC cut in June, with the market underpricing total cuts by at least 20bps this year. As such, we see USD/CAD upside risks and expect the loonie to lag commodity FX peers, especially as the broader US dollar weakens.

AUD/USD:

The Reserve Bank of Australia dropped its tightening bias in March, but blowout jobs data makes a dovish policy pivot less likely for now. We don't forecast

EUR/GBP:

This pair is drifting higher from the 0.8500 floor as the Bank of England inches towards an easing bias.

While we're modestly bullish near-term ahead of the May UK services inflation data, significant EUR/GBP upside may be limited by increased speculation on the timing of the UK general election. Most reports point to October/November as the likely window, with the Conservative party potentially trying to implement another round of tax cuts beforehand. That said, with Labour holding a solid lead in opinion polls as they did before their 1997 victory, the election outcome may not drastically impact sterling.