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(Kitco News) - The U.S. dollar has regained some lost ground after its recent drop of nearly 3%; however, the greenback could continue to struggle as interest rate differentials between the Federal Reserve and other major central banks begin to narrow, according to one market strategist.
In her latest research note, Kristina Hooper, chief global strategist at Invesco, said that peak inflation last year could have also signaled a peak in U.S. dollar strength as she expects to see further declines through 2023.
According to Hooper's bearish outlook, U.S. dollar weakness could continue to support gold prices. In recent interviews with Kitco News, Hooper has been reasonably bullish on gold, saying it continues to play a vital diversification role in investment portfolios.
She said the most significant factor governing the U.S. dollar is the narrowing gap in global monetary policies. The Federal Reserve is expected to raise interest rates by 25 basis points Wednesday, and even if it maintains a hawkish bias, Hooper said that the U.S. is closer to hitting their terminal rate than other central banks like the Bank of England or the European Central Bank.
"The US dollar is weakening as other currencies are strengthening because other economies' central banks, especially the Bank of England but also the European Central Bank, have further to go than the Fed in terms of tightening," she said in her latest note. "That sets us up for an environment in which there is greater differentiation in the near term regarding monetary policy and the economic environment of major economies. With inflation far more problematic in the UK, the US is clearly in a very different place when it comes to anticipated monetary policy. This is also true in the eurozone, though to a lesser extent than the UK."
Beyond global monetary policies, Hooper added that the U.S. dollar is also struggling as an improving economic outlook reduces the need for a safe-haven currency.
"With market sentiment more bullish and the VIX volatility index at relatively low levels, there is little demand for a "safe haven" asset such as the US dollar," she said.
While Hooper expects to see a weaker U.S. dollar, she added that she doesn't expect this to impact its role as the world's reserve currency. Although China's yuan has been competing with the U.S. dollar on the international stage, Hooper said she doesn't see a replacement for the greenback anytime soon.
She noted that the de-dollarization theme that has gained momentum in recent months has been around for decades, and despite all the talk, nothing has changed.
"The Japanese yen and the euro were both considered major challengers to dollar dominance of the global financial system in the 1980s and the 2000s, respectively, but it never came to fruition," Hooper said. "Having said that, today, de-dollarization is about geopolitics and sovereignty, not macro/financial competition. And it's driven by a national security imperative: many governments feel an urgent need to reduce exposure to US/Western financial sanctions, exclusion from the international payment system or, in a potential worst case, reserve freezes and seizures."
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Despite these growing geopolitical trends, Hooper said that she expects the U.S. dollar will remain the world's dominant reserve currency for years to come.
While a weaker U.S. dollar does present some challenges for investors, Hooper added that it also creates some opportunities. She noted that companies with a large global profile could benefit from a weaker U.S. dollar.
"The US tech sector, which derives a substantial portion of its revenue from outside the US, in particular, could benefit from this," she said.
At the same time, she added that Emerging Market economies could also be attractive "given that US dollar-denominated EM debt becomes less onerous to service when the dollar is weaker."
Hooper didn't comment on gold in her latest research note; however, in a recent interview with Kitco News, she said that it still has a path to $2,000 an ounce by year-end.
