If the Fed cuts interest rates deeply, the USD could even lose its status as one of the three highest-yielding currencies next year.
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The dollar weakened this quarter, erasing most of its gains for 2024. The greenback weakened amid traders' speculation that the US Federal Reserve (Fed) could soon ease monetary policy by cutting interest rates.
The U.S. Dollar Index fell 0.4% on Friday afternoon, bringing its quarterly decline to 4%, according to FactSet data. The index, which measures the greenback against a basket of major currencies, is down nearly flat for the year.
Since August, markets have been pricing in the Fed moving closer to a major easing cycle, with Deutsche Bank global head of currency research George Saravelos noting that the decision could knock the dollar out of its top-three yielding position next year.
However, he added that as long as the dollar remains a high-yielding currency, that is compelling evidence that it is strong.
According to Deutsche Bank, the US economy’s GDP growth has exceeded expectations, in contrast to Europe and China. The economy remains strong despite a weak labor market and rising unemployment. Saravelos added that the US has benefited from immigration policies.
He said US interest rates are unlikely to eventually fall below those in countries with weak supply such as the UK. Deutsche Bank Research is also arguing that US interest rates will eventually fall below those in countries in recession such as New Zealand.
Meanwhile, fiscal policy in the US appears set to remain loose regardless of the election. Saravelos said the US economy is less sensitive to low interest rates than other countries around the world.
Fed's decision to cut interest rates
Investors are expecting the Fed to start cutting policy rates later this September.
Futures traders are pricing in a 57% chance that the Fed will cut its benchmark interest rate by 0.25 percentage points. They are also pricing in a less than 43% chance that the Fed will cut rates by 0.5 percentage points.
The Fed has never cut interest rates by half a percentage point, except in an emergency meeting, and if the Fed begins a series of rapid cuts, the dollar would likely weaken, said Saravelos.
However, in his view, a more proactive Fed also means interest rates are more likely to stabilize at higher levels, leaving the medium-term outlook for the dollar unclear.
“The uncertainty for the dollar between now and the end of the year is the Fed’s strategy around the upcoming easing cycle,” said Saravelos.
Theo MarketWatch
