Forex trader half-time report: Dollar dominance in H1 - will it remain king in H2?

During six months in which global equities and cryptocurrencies have tumbled as commodities and inflation have soared, there has certainly been extremity in currency markets. 

The dollar index (DXY) has been on a stunning bull run, reaching 20-year highs by the end of June and climbing against all rivals. 

Meanwhile, FX traders have seen the Japanese yen (JPY) plunge to 24-year lows, commodity currencies such as the Norwegian krone (NOK) on a bumpy ride, and the Swiss franc twice hit parity with the euro (EUR/CHF), which had not previously happened since January 2015.

Capital.com breaks down what we’ve seeen from major currencies, and what to watch for in the months ahead. 

Dollar index (DXY) price chart

US dollar

First half review: The dollar index has risen above 105 in June, a level it last breached in November 2002. 

Dollar strength has come from both its status as a haven currency amid market volatility, and the pricing in of aggressive Federal Reserve rate hiking, which has moved more quickly than peers such as the European Central Bank (ECB). 

Higher interest rates drive currencies up since they generally mean a country attracts more foreign investment and consequently has higher demand for its currency. 

Second half outlook: “I believe the greenback has room to extend its gains during the summer, before signs of peak inflation trigger a massive turnaround,” Yohay Elam, senior analyst at FXStreet, told Capital.com. 

Piero Cingari, analyst at Capital.com, agreed the second half could curtail the dollar’s bull run. 

“While rising interest rates in the US will continue at an aggressive pace, which is favourable for the greenback, there will be inevitable slowdowns in the growth rate of the US economy, with the potential of entering a recession, which could weigh on the currency in a second phase,” Cingari said. 

“Over the past few weeks the market has been starting to price in a slowdown in the pace of the rate hikes, due to these rising recessionary risks. 

“Fed futures point to rates at 3.3% by the end of the year, down from 3.5% earlier this month. This means that the market is pricing in 150 basis points of additional hikes until December 2022. However, if the market kept thinking that signs of a recession meant that the Fed might lower rates in the future, this would likely hurt the dollar index (DXY) in the second half of the year.”

EUR/USD exchange rate

Euro 

First half review: The euro has been on a steady decline against the dollar since the beginning of 2021, and in 2022 has tumbled from a rate of 1.14 to 1.04, leading to speculation about the currencies hitting parity. 

Weighing on it have been the European energy crisis following Russia’s invasion of Ukraine; speculation of a euro area recession (though the ECB has recently downplayed this risk) and slowing production; and the ECB’s slow moves on raising rates even as inflation has spiked to 8.1 % in May. 

Second half outlook: The ECB’s first interest rate rise, of 25 percentage points, is expected in July – its first rise in eleven years. ECB president Christine Lagarge has said she expects an end to the era of negative interest rates by the end of the third quarter.  

However, Elam said, “The euro seems vulnerable to a recession induced by an energy crisis and also by a rethink of European consumers.

“The cost-of-living crisis is set to hit European shores – after tipping the UK economy to the verge of a downturn – and cause the ECB to halt its rate hiking cycle prematurely.”

But David Jones, chief market strategist at Capital.com, said that while things look bearish for the euro, and the major trend is still down, there could be signs of sentiment gradually start to turn for EUR/USD. 

“The last time EUR/USD was this low, in late 2016, was a major turning point for the euro and we saw a rally over the next 12 months. A technical analysis of recent moves may indicate it has reached a bottom, as its most recent dip in June to 1.0360 did not reach the year-to-date low it hit in May of 1.0350.

“We have seen markets very bullish on the US dollar, but we could now see a pullback and a spring back in currencies like the euro.” 

See David Jones' full analysis of EUR/USD with trading tips here:

Japanese Yen 

First half review: 2022 can only be described as a torrid year so far to the yen. 

What began as a depreciation that officials defended as managable and even good for Japan’s economy as it maintained powerful monetary easing at a time when its rivals announced the start of tightening, has turned into a significant concern. 

Officials have now said the currency move – with its rate against the dollar going from 115.14 to 135.44 this year – has made it difficult for businesses to make plans as rising inflation has also begun to squeeze households.

However, the Bank of Japan stuck by its policy in its June meeting. 

USD/JPY exchange rate

Second half outlook: For now at least, “The trend is your friend” said Kenneth Broux, FX strategist at Societe Generale, following the dovish outcome of the June meeting. 

However, various analysts have suggested it may prove impossible for the Bank of Japan to hold its course much longer on its current trajectory. 

As Elam predicted, “I think inflation will reach Japan later in the year, causing the Bank of Japan to abandon its ultra-loose policy, resulting in a stronger yen. Overall, there is room for an extension of the current trends during the summer, before significant shifts in currency trends in September.”

Capital.com's Piero Cingari added that it would indeed take the Bank of Japan to stop talking about currency market intervention and signal an increase in interest rates or the abandonment of stimulus measures.

“A global recession could be the answer, as the yen has historically performed well during recessions, however, the moment has not yet come,” he said. 

Pound

First half review: Not quite as (though nearly) as gloomy has been the situation for sterling, which has dropped to its lowest level since the start of the pandemic over the first half of the year. 

That has been despite a series of rate rises by the Bank of England, as the UK has reported the highest inflation rate in the G7 along with a slowdown in economic growth and forecasts of a recession, putting stagflation concerns front and centre. 

GBP/USD exchange rate

Second half outlook: “The pound has already priced in a significant amount of negative news, and the market is not especially optimistic on BoE rate rise prospects, pricing in cumulative raises of 1.7% over the next five meetings,” said Cingari. 

 “If the BoE surprises the market with stronger hikes than expected, the pound might benefit.”

He added that for a sustained recovery in the GBP/USD exchange rate, the BoE must act more aggressively than the Fed – but the key question will be whether it can do so with the increasing risks of a recession, which the BoE has itself forecast. 

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