Goldman with the argument.
USD: Diminished, not finished.
We downgraded our Dollar forecasts last week but still expect some Dollar strength from current levels.
…we think the market has rapidly repriced the shift in the growth outlook, and ran ahead of the forecast changes our teams have made for 2025.
In the case of the Euro area, FX markets appear to be giving an unusual amount of credit to distant growth prospects—likely on the possibility that more balanced global growth prospects will prompt a shift in global capital flows and an outsized FX move, like what happened in 2017.
So far, there has been some rotation, but it has been relatively limited compared to the amount of investor attention.
We think it is sensible to be attentive to this risk, but note there are a number of important differences between then and now.
We think it is important that the 2017 rebalancing flows came just after a period of US growth disappointment in 2016, and then surprising EA strength in 2017.
Most notably, and different from today, in both years Euro area growth matched that of the US (Exhibit 1).
For 2025, while our expectations for US growth are now more muted, we still expect US growth of more than double the Euro area this year—while the US growth downgrade is a bigger change to our view, we are slightly below consensus on both the US and EA.
If the Bessent plan to hand off growth from public to private spending is to work, it has to lower financing costs much further than today.
That means keeping the heat on fiscal spending until the US long bond gets a much larger bid than it currently has. Yields need to fall 1% at least, and this is while tariffs are adding to inflation.
To achieve that, markets are going to need a fair dinkum US growth scare.
That said, US inflation is not still coming down and is not as bad as markets fear, so a recession may not be necessary (if one can control such things amid pretty chaotic policy implementation).
Meanwhile, German spending is likely to be frontloaded, in part to fight the Ukraine War but also because its car industry is under assault from Chinese EVs. It has a new government and needs a new growth model.
It will take time for the German budget loosening to trickle into other EA jurisdictions, but that will happen too.
So, I don’t think a decent lift in European growth is as distant as Goldman suggests. The ZEW is already on the moon.
Hence, I am still on board with a convergence in US and European growth rates that means a lower DXY and higher EUR.
AUD should be carried higher, with a Chinese-inspired lag.
But only to a point. If markets really get spooked by the US growth outlook, then we’d likely see a safe haven bid into DXY and everything else falling.
