The dollar led a significant strengthening movement against the basket of currencies in the world for most of the last year. In fact, the dollar jumped 27% from May 2021 to September 2022, bringing it to a two-decade high. It remained stable for about two months and since last November it has lost 9% and the question is of course what’s next.
The reason for the great strengthening of the dollar against the currencies of the world
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, is mainly the increase in interest rates in the US – this created a significant margin in favor of the US dollar. Investors say to themselves, I can get a risk-free US interest rate at a high interest rate of 4.5-5% so why invest in something else? In addition, people are going to invest in the dollar when there is an increase in risk or the fear of a global recession. This affected investors throughout most of 2022 and the result accordingly (click here for a moving graph). 
So what caused the change of direction in the last three months? The dollar tends to move in combination with investors’ views on where interest rates are expected to go in the US, and on how well the US economy is performing in relation to the rest of the world.
The assumption is that we have reached the end of the road for interest rate hikes in the US – when inflation in the US has not yet returned to the Fed’s target area (average inflation of 2% per year) and the truth is that it is still far from there (standing at 6.5% as of December). The reason this lowers the dollar, even though inflation in the rest of the world is not approaching the target range and is actually higher than in the US (for example, 8.5% in Europe and more than 10% in the UK) is that if the interest rate in the US stops and the interest rate in the rest of the world rises – then a gap The interest rate that has now expanded will be reduced. Beyond that, it is also possible that investors fear that the Fed will not be able to continue to be determined in the fight against inflation (through continued interest rate hikes).
Analysts believe that the main factor that will affect the movement of the dollar against the basket of currencies in the near future is the growth prospects of the US economy and the question – whether there will be a “soft landing” or a “hard landing”.
Deutsche Bank macro strategist Alan Ruskin charts the directions. According to him, “It is possible that the blockbuster jobs report added to the chances of a soft landing in the American economy in the coming six months, but also increases the chances of a hard landing in the longer term.” The jobs data indicated a rapid increase of 517 thousand jobs, well above the expectation of an addition of 190 thousand. The unemployment rate in the US also remains low – only 3.4%. In any case, Ruskin defines a hard landing as “anything that falls into the realm of a recession by the NBER [הלשכה הלאומית למחקר כלכלי]apparently – two quarters of negative real GDP growth”.
Ruskin presents four possible scenarios for US growth and interest rates, and how the dollar might react against currencies in the 10 largest economies, the G10, and emerging markets (EM). Scenario 2 seems to be his favorite: under this scenario, In the next six months, the dollar will remain unchanged (and perhaps strengthen) relative to the G10 currencies, but it is expected to weaken in the second half of 2023. At the same time, he estimates that emerging market currencies will perform weakly relative to the dollar until the end of June, as well as against the other G10 currencies He expects emerging market currencies to weaken relative to G10 currencies throughout the year.
“Part of the reason for the recent growing optimism about a short-term soft landing is that inflation has improved even though the job market remains strong. But – there is a growing risk of a hard landing after the next six months because the Fed will try to control inflation and continue to tighten financial conditions – which increases the chances of policy mistakes” , Ruskin said. That is, he expects that the interest rate will continue to rise even beyond 5-5.25%.
According to him, “This is exactly the opposite of the path we seemed to be on until the employment report data for the month of January was published. It seems that the risks of a recession will continue after the next six months,” the strategist wrote.
Here are the four deafnesses according to Deutsche Bank:
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