Expect 'one last hurrah' for the dollar before a 2023 recession chips away at its dominance, Wells Fargo says

• The dollar's dominance will wane next year once the US economy slips into a recession, Wells Fargo said.
• It will mount one last charge in Q1 before weaker growth prospects mark a turning point, it said.
• The dollar has stormed higher in 2022, but slipped recently on hopes the Fed will ease up on rate hikes.

The dollar's global dominance of other currencies will wane next year once the US economy slips into a recession, according to Wells Fargo.

But the US currency will mount one last charge in the coming weeks before hitting that turning point, the bank's strategists said in a note published Friday.

"The greenback can experience one last bout of renewed strength before entering a cyclical period of depreciation against most foreign currencies," the team of Wells Fargo economists wrote.

The strategists led by Nick Bennenbroek, Brendan McKenna, and Jessica Guo shared their forecast for the currency — titled "One Last Hurrah Before the US Dollar Decline"— as part of the bank's 2023 economic outlook.

They forecast the dollar will likely rally 2% in the first quarter of 2023, before dropping by almost 10%. They expect the US to slip into a recession in the second half of 2023, which will weigh on the dollar as economic confidence falls.

"The resilience of the US economy that supported the greenback in 2022 should start to fade, and we believe waning growth prospects will mark the inflection point for the dollar," they said.

The US Dollar Index — which tracks the buck against a basket of six other currencies — has jumped 8.9% year-to-date, driven higher by the Federal Reserve's aggressive monetary tightening.

The US central bank has raised interest rates from 0.25% to 4.5% this year, making the greenback more attractive to foreign investors seeking higher yields.

But the dollar has lost some of its shine since the start of November, falling 6.7%. Investors have increasingly accepted the Fed could start easing up on its tightening campaign as inflation slips away from four-decade highs.

Wells Fargo expects the dollar to rebound at the start of next year, as the Fed defies those market expectations by pressing ahead with rate hikes to ensure inflation falls towards its 2% target level.

"The Fed is likely to continue with its hawkish stance on monetary policy for the time being," the bank's economists said. "We believe the Fed is likely to deliver more interest rate hikes than financial markets are priced for, and indeed more tightening than many other central banks."

"All in all, we believe the trade weighted U.S. dollar index can rise 2% from current levels through the end of the first quarter of 2023," they added.

That brief rally is likely to be followed by a period of significant weakness as recessionary fears rattle investors, Wells Fargo warned.

Its economists predicted that the Fed will ease up on its rate hikes late next year, which could further weigh on the dollar heading into 2024.

"We expect the Fed to begin easing monetary policy by lowering its benchmark policy interest rates," the Wells Fargo team said. "With both growth differentials and interest rate differentials swinging against the greenback by early 2024, we expect dollar depreciation to gather momentum and become more pronounced."

"We expect the US dollar to soften 9.5% by the end of 2024," they added.

Read more: King dollar's worst slump in over a decade is hammering one of 2022's biggest winners - but the greenback's dominant run might not be over just yet