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U.S. dollar is losing its appeal as 'safe-haven currency of last resort' - PIMCO

Kitco News

(Kitco News) A strong U.S. dollar was one of gold's main obstacles last year as investors embraced the currency as a safe haven. But that outlook is drastically changing in 2023 as Pacific Investment Management Co. forecasts a significant downward trend for the USD.

"We expect the USD will continue to lose its appeal as the safe-haven currency of last resort," PIMCO's global strategist Gene Frieda said in a note. "We believe risk premiums will decline as inflation – and monetary policy volatility decline."

The strategist points to easing fears around a global recession and new disinflationary trends.

"While higher yields clearly worked in the dollar's favor last year, any forward-looking view must also take into account how the dollar was buoyed by the shocks of 2022 – the Russia-Ukraine war, the spike in energy prices, and inflation – and the extent to which they may abate in 2023," Frieda wrote earlier this week. "PIMCO believes the dollar, which has depreciated since hitting a 20-year peak last September, is likely to fall further in 2023 as inflation falls, recession risks decline, and other shocks abate."

Even Federal Reserve Chair Powell acknowledged that inflation is starting to come down. "It is gratifying to see the disinflationary process now getting underway," Powell said Wednesday. "We can now say, for the first time, that the disinflationary process has started. And we see it really in goods prices so far." 

And as markets look toward the end of the Fed's aggressive tightening cycle, the dollar's safe-haven appeal will dissipate, and the overall risk appetite will rebound. This outlook comes after the dollar already peaked in September of last year.

PIMCO's forecast includes one more rate hike from the Fed following the central bank's February decision to hike at a slower pace of 25 basis points. The latest rate increase means the Fed has hiked by 450 basis points since the start of this tightening cycle.

And once the Fed pauses, the dollar's yield advantage over currencies will narrow. This is especially relevant when it comes to the European Central Bank, which still has a lot more work to do in terms of raising rates. 

On Thursday, the ECB raised interest rates by 50 basis points and signaled that more aggressive rate hikes are coming.

"Given the faster pace of cumulative rate hikes on the way up, the USD's yield advantage is likely to fall in the early stages of a rate-cutting cycle, even if the dollar sustains its relatively high yield," Frieda said.

Another driver working against the U.S. dollar is China's reopening, Frieda added. "The end of China's zero-COVID policy, at least to the extent it leads to a firm recovery," he said.

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