Everything seems to indicate that in September the Fed will begin what will be a cascade of interest rate cuts, a complete change in its policy that was reinforced by the president’s speech in Jackson Hole. That is why some hope that, like the dollar, which is already at its lowest in 2024, on the eve of the end of the era of high interest rates, a real downward spiral will now begin. This scenario can trigger inflation on North American territory and cause huge changes, for better or for worse on the market and it is not in vain that the powerful revaluation of the yen has caused a real disaster on the Japanese stock market. However, Analysts are calling for calm in the market, they believe that the dollar has already touched the ground and this, in fact, will be a source of surprises in the coming months, acting in a completely counterintuitive way.
Since the beginning of August, the dollar index (which compares its price to that of a basket of major international currencies) has fallen decisively by 2.59%. This, added to the decline in July, means that in less than two months it has already fallen by 4.22%, thus erasing all gains and remaining at a minimum of 2024. The exchange rate against the euro has been virtually identical, down 2.7% so far in August, trading the US currency for 0.9 euros. For the yen, the decline is 6.8% and 1.9% for the yuan.
So why, for many, is the dollar showing no signs of continuing its decline? The reason is that the market has already fully digested the Fed’s correction and this has already been priced in. Andrea Cicione and Daniel Von Ahlen, analysts at TS Lombard, defend this theory, arguing that the currency “has weakened considerably in recent months to lows as markets were betting on a change in the Fed’s course.” However, “this trend seems to have exhausted itself, which does not make us pessimistic.”
In fact, experts believe that many analysts agitated by recession fears are “exaggerating the relationship between the Fed’s policy and that of other central banks,” which could bring positive surprises for the North American currency. “Historically, the Fed has taken a relatively gradual approach to easing its policies during soft landings, which contrasts with current market prices.” Currently, the market for exchanges grants a reduction of 100 basis points for the next three meetings, that is, until the end of 2024. They hope, in turn, that by June 2025 they will have made a reduction of 75 points in the “price of money”.
Shivan Tandom, an analyst at Capital Economics, says this disruption from the supposed outlook is something that has played out repeatedly every time the Fed has aggressively raised the price of silver. “Five of the seven easing cycles since the 1970s show a strengthening dollar in the year that the peak (in rates) was reached.” Only two scenarios (late 1980s and mid-2000s) could result in a decline in monetary flexibility. Several factors lead analysts to think a bit more weakness given that the stock remains “relatively valued” but “the room for maneuver is really limited.”
Not everyone agrees, and ING analyst Francesco Pesole argues that “we believe the prospect of Fed easing means that short dollar positions will continue to prevail.” In short, the Dutch bank believes that “the way markets are trading Fed easing is similar to December and “We see no reason to predict a reversal of the dollar’s downward trend at this time.”
The “dance” with other central banks
In this cycle of rate cuts, one of the most important factors for the movements that occur in the currency market is the interest rate differential between two economies. Money always seeks the highest risk-adjusted return, and a high interest rate generally attracts money. High rates put upward pressure on bond yields in the market and investors, always taking into account the risk associated with this investment, tend to buy these bonds and, to do so, they convert their currency into that of the security they wish to acquire. , generating increases in the latter compared to the currency of the foreign investor.
By this logic, the fact that the Fed is going to start cutting rates should not be good news for the US dollar, since, as we have seen in recent weeks, the US bond has reduced its yield to adapt to the central bank’s movements. . American. However, there is an element that must also be taken into account and that plays in favor of the dollar in the upcoming rate reduction process: many other central banks are also lowering the reference interest rate in their economy.
The Fed, in fact, will start the cycle of lowering the price of silver later than the ECB, which has already started it, and markets expect an aggressive reduction from the European body in the coming months, and from many other central banks, such as the Bank of England. This will help prevent an aggressive depreciation of the dollar against the euro and sterling.or even, it could support some gains in the US currency in these important crosses. Today, markets are buying a 150 basis point rate cut by the ECB. by the end of July 2025, at the eight official monetary policy meetings the central bank will hold during that period.
For the Bank of England, the market is already expecting a rate cut of 100 basis points over the next 12 months, until July next year, and investors are also anticipating a drop in the price of silver in the coming months in countries such as Canada, Sweden, the Czech Republic, New Zealand… a long list of countries whose rate movements indicate that their currencies will have no problem appreciating strongly against the US dollar.
From Capital Economics, they point out that “our forecasts for monetary policy in the major economies largely coincide with what is being discounted in the money markets, suggesting that for this reason there is limited scope for further weakness in the dollar,” the director points out. “However,” he continues, “this implies that the Fed will cut rates more than most of its peers, meaning that short-term interest rate differentials will continue to shift against the United States,” warns Capital Economics.
A counter-cyclical currency that loves “fear”
In any case, another factor that encourages the defenders of the dollar is precisely the possibility of a global economic slowdown, especially in China, but with a repercussion in the rest of the world. According to BCA Research, “the dollar is a countercyclical currency” and therefore, even if there were a recession in the United States, “it would turn into a global slowdown.” In fact, “the US economy is more focused on services than on manufacturing, compared to the rest of the world. When global growth accelerates, capital often flows from the United States to the rest of the world, which increases the demand for foreign currencies and reduces the demand for dollars.” However, global weakness would cause the opposite effect.
Capital Economics believes that a resilient economy will lead to sustained risk appetite, which could put pressure on the dollar. However, “corporate credit spreads have returned to extremely low levels. Therefore, the scope for further dollar weakness is likely limited, also for this reason.” They also point out that if the US economic performance were to be worse than expected, “we would see a further episode of monetary strength.”
For its part, TS Lombard comments that it sees a very weakened Chinese economy “with almost negative nominal GDP growth” stuck in a context that “pushes China’s macroeconomic trajectory from weak stabilization to a drastic slowdown.” This factor also works in favor of dollar Well, “an even weaker China could negatively impact commodity prices, weakening emerging market currencies and precipitating flows to the safety of the dollar.” In fact, we are already seeing prices of a wide range of commodities falling sharply, such as oil, iron, copper… etc., precisely because of much weaker demand from the Asian giant.
The Kamala-Trump Factor
There is one factor that would distort the market and that shines above the others in the short term: the US elections. Kamala Harris and Donald Trump will face each other in an all-out electoral contest that will end in November… and in which the fate of the dollar will be decided, since the tariffs and other measures of the New York tycoon have generated a broad consensus that they would imply sharp increases in the currency.
In this sense, one of the factors that many attribute to the recent fall of the dollar comes from the great comeback in the polls of the Democratic candidate, who went this month from being a very small option to a slight favorite in the polls. “The fact that the US dollar has weakened since early August is a bit strange.in our view, because this happened during a period when US data (retail sales, initial jobless claims, ISM services) indicated a return to relative strength in the US, following fears of a recession ahead in late July and early August,” Thierry Wizman, global rates and currencies strategist at Macquarie, said on Tuesday.
From TS Lombard, they comment that what happened this August is that “bets on Trump have once again gone out of fashion amid the increasing odds of a Kamala Harris victory in the US presidential elections in November, which could have contributed to the weakening of the dollar. For the firm, “Harris is seeking to position herself as an anti-inflationary candidate. The core of her economic proposals (including facilitating and encouraging housing construction and reducing medical costs) appear disinflationary compared to the huge tariffs that threaten under a second Trump administration.” However, the firm points out that “the political cycle is very volatile and the pendulum can swing in a matter of days, meaning that an improvement in Trump’s chances could help the dollar rise.”
