The dollar's turbulent upward trend signals the end of an era

The dollar’s turbulent upward trend signals the end of an era

The US currency is hovering at its lowest level in more than a year after signs of slowing inflation boosted bets that the Federal Reserve will soon stop raising interest rates. Dollar bears are looking further afield, to what they say are inevitable rate cuts, something the market consensus sees happening sometime in 2024.

“Our call for the dollar to enter a multi-year downtrend is based in part on the fact that the Fed’s tightening cycle will turn into an easing cycle, and that will drive the dollar lower even as other central banks cut as well,” Stephen Barrow, G10 strategy chief at Standard Bank, in a note on Friday.

The Bloomberg dollar gauge was little changed in early Asian trading on Monday. It fell 2% last week, the largest weekly drop since the five days through Nov. 11.

It is difficult to overestimate the potential ripple effects of a slide in the dollar in the long run. It would lower import prices for developing countries, which would help ease inflation pressures. The dollar’s reversal also supports currencies such as the yen, which has been declining for months, and the Flip common trading strategies associated with weak yen. More broadly, a softer US currency tends to boost the exports of US companies at the expense of their counterparts in Europe, Asia and elsewhere.

The 2% decline in the Bloomberg Dollar Index last week also contributed to gains in dollar-priced commodities such as oil and gold.

Many investors were waiting for A Downtrend in the dollar Its most popular sell-off has fund managers from M&G Investments to UBS Asset Management poised to outperform the likes of the yen and emerging market currencies.

“The most likely path forward is for the dollar to remain weak over the coming months,” said Peter Vassallo, fund manager at BNP Paribas Asset Management. He bets on the gains of the Australian dollar, the New Zealand dollar and the Norwegian krone.

What Bloomberg Strategists Say:

The prevailing downtrend in the dollar is set to remain in place while the real yield curve flattens. One of the best leading indicators for the dollar, for example, is the real yield curve. The intuition is that the dollar is margin driven by the real return of foreign investors to US revenues.

Simon White, Macro Strategist.

Of course, there is a long history of investors getting upset over early bets that Fed rate cuts would sink the dollar. Such was the case early this year, when the currency appeared to be on the verge of a prolonged downtrend only to stabilize as US economic data pushed home that the Fed was not about to stop rallying.

For the bears, the threat is that the dynamic is repeating itself, especially with the Fed potentially tightening further as soon as this month.

At Invesco Asset Management, Georgina Taylor wasn’t ready to reduce her dollar exposure just yet. Still in data monitoring mode, it isn’t ready to end the battle to tame inflation.

“The interest rate differential story is volatile but I’m not going to give up on the dollar,” she said, given that the absolute real yield differential remains high.

The US’s economic resilience is why Michael Cahill of Goldman Sachs predicts that any decline in the dollar will likely be slower than in previous cycles. However, support for the dollar could collapse if the Fed calls for an end to the inflation war even as the European Central Bank is forced to keep interest rates higher for longer.

“The biggest risk that could lead to a further decline in the dollar is that the inflation picture is diverging,” said Cahill, a currency strategist at the Group of Ten. The bank expects the dollar to weaken to $1.15 per euro in 2024, from about $1.12 now, and that the yen will rise to 125 per dollar, from about 139 now.

Dollar bears can also rely on valuation measures. The currency’s strength was particularly pronounced against the yen, to the point where the real effective exchange rate is the Japanese currency commerce near its lowest level in decades.

“From a valuation perspective, the dollar is still very overvalued,” said Paresh Upadhyaya, director of currency strategy at Amundi Asset Management. “I think the markets are going to start to fade.”

He points to the US’s twin deficits – its trade and budget deficits – as a structural headwind. But it also bears in mind another dynamic often cited by market watchers, which is the dollar smile theory.

It is widely believed that the US currency usually gains when the US is either in a severe recession or a strong expansion – and falters during times of moderate growth.

“If the US designs a soft landing, this is probably the best case for a weak dollar you can ask for,” Upadhyaya said. © 2023 Bloomberg LP DM


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