Beginning 2021, we were among the few in the FX industry calling for a higher dollar, particularly relative to the Euro (and less so the Yen). Our reasoning for this was that the US monetary and fiscal response was so strong, immediate and efficacious, that the credit creation machine in the US would outperform those of other countries. Indeed, this is what we have seen across asset markets, with a stronger dollar the general theme:

Above, we show that the dollar has indeed rallied year-to-date. The notable exception above is the Pound (GBPUSD). Indeed this too was in line with our expectations. While these moves aren’t over yet, the fundamental environment looks to be shifting. Our expectation is that US growth and inflation will be solid in the first half of this year, exhibiting continued growth outperformance. If fundamentals play out this way, it is most likely that the US will develop conditions conducive to a Federal Reserve balance sheet taper. While the taper may not be instituted by the end of the year, we expect the narrative to become strong around then, i.e., markets will begin to reflect that. Below, we show the performance of major country currencies during the last taper:

There are two things we need to note from the above. The first is that tapering puts significant pressure on currencies, especially currencies engaged in their quantitative easing (BOJ and ECB). Given the US will likely be out of the recession faster and stronger than the Euro and Japan, we expected the same dynamic to repeat itself. However, the is a considerable amount of time before this narrative plays out. Until then, we think the global risk will remain well-supported, especially in the next few months. Nonetheless, we think setting up for the next big moves will create the most opportunities for us to trade, and we should start thinking about these moves well in advance.