Has the U.S. dollar peaked?

The U.S. dollar has been the best performing major currency so far this year in 2022, but it has declined by nearly 8% versus its highs in September. That movement’s pretty swift. It's mostly occurred in November, and it's also been very broad-based in the sense that it's not just one or two currencies that have benefited, but really the vast majority of G10, and emerging market currencies that have rallied as the dollar has fallen.

That's important because it possibly marks a long-term peak in the U.S. dollar. We've been through this period for 12 years now where the dollar has risen and if this is indeed the peak in the dollar, then it marks a completely different environment for FX markets and it also has very important implications for other asset classes like equities and commodities.

So investors are really starting to embrace this idea that the dollar peak may have already passed. And there's three real developments that have contributed to that change in sentiment. The first is the developments in Europe, where there was previously a lot of pessimism built in. But investors have started to trim their short positions in response to better economic data and a rebuild of natural gas inventories, which looks like Europe might be in reasonable shape throughout the winter.

The second is headlines from China that COVID restrictions might be relaxed. That offers hopes to global markets that economic growth globally might not be as bad as feared and will help weaken the dollar just by pulling capital away from the U.S. And third, I think there's been this acknowledgment that the Fed is near the end of their hiking cycle.

That's been a major tailwind for the greenback over the past year and the removal of that tailwind is a marginal negative. Now these turning points in the dollar, they tend to be a once in a decade event. And just given the very important implications for FX markets and global economies, it's really worth keeping an eye on FX markets here.

We suspect that in the short term, we might see some choppiness in foreign exchange rates just as the dollar completes this peak, and that the longer term outlook will include a significant amount of U.S.-dollar weakness over the next coming couple of years. That's good news for the Canadian dollar. It's also good news for other emerging and developed market currencies.

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Original Publication date: December 22, 2022