Currency analyst: ‘There’s room for the dollar to strengthen’ in 2022

MUFG Bank Currency Analyst Lee Hardman joins Yahoo Finance Live to discuss 2022 expectations for the U.S. dollar, weighing the dollar against the Turkish lira, Argentine peso, and Chines yuan, and the overall 2022 currency outlook.

Video Transcript

- We know that President Biden believes in a strong dollar, or does he? The DXY started out the new year with a little bit of a bump here. But we want to talk about everything in the currency market with Lee Hardman. He is the MUFG bank currency analyst. And Lee, thank you for joining us today.

Just want to get your big picture view on the US dollar because I'm looking at a very non-trending asset over the last month or so. But we did see a spike up in November. And I'm just wondering if you expect that to continue or if there's going to be some kind of mean reversion, and what the catalysts are going to be.

LEE HARDMAN: I know. Thanks for inviting me on the show today. Yeah, like in terms of our outlook for the dollar, we still think there's room for the dollar to strengthen further as we go into the first half of this year. Obviously the main kind of catalyst for the dollar strengthening towards the end of last year was the kind of aggressive repricing of FED tightening expectations. And we think that theme will continue early this year.

We're not expecting this new Omicron COVID variant to significantly disrupt the recovery in the US. So we think the FED can continue to look through this period of higher COVID cases and that their focus is going to be on addressing upside risks to inflation. So we think pressure will continue to remain on the FED to potentially further speed up their plans for tighter policy.

Obviously at the December meeting, they already signaled that they're looking to hike rates three times next year. So that's pretty much kind of fully priced in now into the US rate market but we still think there is some scope for markets to price in even more tightening this year, and potentially further out the curve as well.

Because if you look at the pricing for the terminal rates in the US, it's still around 2%, which is still quite low from a historical perspective. So we still see some upside risks to short term US rates and the dollar.

- And how extended are those going to be? I'm curious, in the past when we've seen rates start to go higher, what that has meant for the dollar. In other words, we tend to see an anticipatory move, right, and so I wonder once rates go up, how historically, how much that has been extended.

LEE HARDMAN: Yeah, like as you say, the dollar did well last year and it is trading now. It's certainly more overvalued levels, particularly against kind of the major currencies such as the yen and the euro.

So if you look at our forecast for this year, we are still showing some further dollar upside into the first half of this year but the scale of the move higher from here we think is going to be more modest than what we've seen in the past. And I can say that partly reflects the fact that a lot of that kind of good news and higher rate stories out--

- Oh-oh. That's a new one in the pandemic. You all right, Lee?

LEE HARDMAN: Yeah, on the count but I flexed it, I'm good.

- Well let me ask you. We were talking over the break briefly about the Turkish lira, the incredible volatility we've seen in that US-- in that currency. And let's just pull up a chart here. This is a currency that's moving multiple percentage points per day, which is absolutely almost unheard of in the currency markets.

You take a look at the trailing year, it has lost 82% of its value versus the US dollar here. So when the US dollar is gaining strength and the Turkish lira is weakening, that's when we see the spike in the chart.

But what do you make of this? Turkey has kind of a novel view towards monetary policy. Is it that-- is it simply that or is this part of some larger concern that we should have because the Argentine peso as well has been losing steam. You can see, it's been devalued about 21% over the last year.

LEE HARDMAN: Yes. As we saw for most of last year, Turkish lira is weakening very sharply and the kind of main trigger really is just the kind of inappropriate policy settings in Turkey where the president and the government in Turkey are determined to maintain looser policy to try and support growth. And there's a real concern amongst investors and also domestic participants that they're not paying enough attention to upside risks to the inflation outlook.

And as we saw in the latest producer price inflation report from Turkey, that showed PPI inflation up to 80% almost in the latest report. So inflation is a very, very big problem in Turkey and that's not been adequately addressed by policy makers.

And even the latest kind of policy action we saw from the government last month where they came out to try slow down the pace of the dollarization in Turkey by using the government's balance sheets to effectively kind of cover for any further losses for lira deposit holders.

That in itself might slow the pace of lira depreciation in the very short term but ultimately it doesn't really seriously address concerns over the appropriateness of the policy in Turkey, which remains to loosen while inflation pressures are continuing to build.

We still feel that the risks are still very heavily tilted to the downside for the lira going forward. And unless we see a shift in policy in Turkey to move back to more kind of conventional policy settings, then it's very difficult to see a sustained turn around for the lira. And that kind of very sharp appreciation we saw last month, that to us just a temporary move which is likely to reverse going forward.

- And let me ask you about the Chinese Yuan as well because we have that up on the WIFI interactive. The US dollar has lost by 8 and 1/2% versus Yuan over the last two years. That means it's been strengthening, the Chinese currency. And this is over a time period when there are heightened tensions between the US and China, they're going after their own tech giants.

Just wondering what you make of this as they're pulling some of their own companies out of the capital markets in the United States like Didi, into their own. Any of this making sense in terms of the currency picture?

LEE HARDMAN: Yeah, like obviously last year the renminbi was one of the best performing currencies, even outperforming the dollar which obviously did well more broadly. To think of one of the kind of key reasons why the renminbi has been outperforming is being the kind of shift that we've seen in terms of patterns for consumption globally. Obviously during the pandemic there's been more demand for goods, which has helped sort of export growth from China.

So we have seen China benefit from that, demand for their exports. That's led to record trade surpluses over in China and we think that's a key reason why the renminbi has been strengthening during this period. Going forward though, this year we do think some of those kind of appreciation pressures on the currency will start to fade.

As we kind of move further through the pandemic, we would expect some further kind of normalization to happen in terms of consumption patterns. More of a shift away again from goods and back towards services, which should help to shrink the track Chinese trade surplus. And at the same time, like you say, China's economy does face some downside risks as well from the ongoing slowdown in the real estate sector.

And we think policy makers in China will respond to those downside risks to growth. As we've seen over the last month or so, they have shifted towards a looser policy stance. So we do expect to further loosening of monetary policy from the PBOC this year.

And I think at the same time is with the FED also moving to speed up the pace of tightening, that kind of widening policy divergence between the US and China. We think ultimately, that will help as well to slow down the move we've seen in dollar CNY to the downside.

- All right, we've got to leave it there but really appreciate your thoughts on this. Lee Hardman, MUFG Bank Currency Analyst.