The evidence for a dollar peak is inconclusive

Socgen believes the dollar is currently overvalued and likely to retreat in the medium term, but domestic and global factors warrant caution in predicting a peak at this stage.

While expectations for Fed policy tightening have eased somewhat, this confidence may prove misplaced, especially if inflationary pressures prove more persistent than expected.

According to the bank, “another round of bond sales could lead to the DXY attempting to make another high, especially if risk sentiment suffers.”

The bank remains confident in predicting long-term dollar losses, “In the longer term, the dollar’s rally is no doubt in its final stages.”

The war in Ukraine is still the key threat to the euro

The bank also expects the euro to strengthen in the medium term, especially as it is trading well below fair value:

“EUR/USD is undervalued relative to current economic data and monetary policy, and the long-term outlook is clearly positive.”

However, Socgen believes the currency will remain vulnerable in the short term, primarily due to the war in Ukraine.

The bank believes the war poses a serious threat to the Eurozone economy, especially given the vulnerability of the energy sector.

There are bilateral risks, as the war could be a powerful push that finally forces EU governments to adopt more aggressive and supportive fiscal measures.

Such a shift in fiscal policy would allow for tighter monetary policy and an end to the negative interest rates that have undermined the currency.

However, while market fears about the situation have eased for the time being, Socgen believes there is a serious risk of complacency.

The bank notes: “While markets may be temporarily distracted by news of the conflict in Ukraine, it remains a serious risk. We forecast the euro to strengthen in 2023, but we are not yet willing to buy it or most other European currencies.”

In this context, the downside of the euro should the conflict escalate is much greater than the potential upside.”

The bank adds: “We believe the euro is almost impossible to buy because the tail risks from war are very large.

The yen is being held back by yields in the US

Socgen notes that the yen is significantly undervalued from a fundamental perspective. Even with rising yield spreads, the company believes the fair value of the yen is around 115.00, and this value would be much lower if yield spreads moved against the dollar.

However, the dollar/yen (USD/JPY) peak could be delayed if US yields come under renewed upward pressure and the 10-year yield sets a new three-year high above 3.20%.

The pound sterling is noticeably weaker

On sterling, Socgen highlights weak fundamentals, focusing on the balance of payments, which retains an underlying vulnerability.

It notes: “The more the balance of payments matters to the currency relative to other factors, the more challenged sterling is.”

The bank expects the second quarter current account data, published at the end of June, to be abysmal with a widening deficit.

It also notes that the UK is still making net payments to the EU under the EU withdrawal agreement, which undermines the income account and represents an additional burden on the balance of payments.

According to Socgen, fair value for the EUR/GBP pair is 0.85-0.90.

He adds: “The pound has come a long way down but the news flow is not helpful. The economy is creaking under the weight of rising inflation, the balance of payments is in dire straits and the government remains under pressure.”

AUD is severely undervalued

In terms of commodity currencies, Socgen believes the overall picture is mixed, with the strengthening US dollar a clear headwind, especially in the short term.

Nevertheless, the firm sees the Australian dollar as a potential exception and notes that “at 70 cents, the Australian dollar remains severely undervalued.”

The bank also expects medium-term gains in the Canadian and New Zealand dollars as the U.S. currency loses ground.