Analysis: Bears Circling Weakening Dollar as Fed Rate Cuts Approach – Reuters

By Saqib Iqbal Ahmed

NEW YORK, Sep 5 – The U.S. dollar is experiencing a significant decline, as expectations of interest rate cuts by the Federal Reserve are on the horizon, potentially marking the end of its extended strength.

Having dropped 5% from its 2024 peak, the dollar is nearing its lowest level in nearly a year against a selection of other currencies, following a sharp decrease last month.

This decline is driven by an anticipated reduction in U.S. interest rates. For several years, the robust U.S. economy and persistent inflation have kept interest rates significantly higher than in other developed nations. This has made dollar-denominated assets more appealing and sustained the currency’s value even after it reached a two-decade high in 2022.

The yield advantage is expected to diminish now that inflation has tapered off. Fed Chairman Jerome Powell indicated last month that the "time has come" to initiate rate cuts, with the process anticipated to start at the central bank’s monetary policy meeting on September 17-18.

"We’ve always believed that almost regardless of other conditions, once the Fed begins cutting rates, the dollar will lose ground," stated Brian Rose, a senior U.S. economist at UBS Global Wealth Management. "That view remains unchanged."

Understanding the dollar’s trajectory is crucial for investors, considering its pivotal role in global finance. A weaker dollar could enhance the competitiveness of U.S. exporters’ products overseas and reduce costs for multinational corporations converting foreign earnings into dollars.

The extent of the dollar’s potential decline in the long run will likely depend on how deeply the Fed cuts rates in the coming months and how quickly other central banks react.

Currently, the U.S. economy seems stronger than many of its counterparts. The yield difference between 10-year U.S. Treasuries and comparable German bonds has narrowed in recent months but still hovers around its five-year average.

Investors are betting on substantial rate cuts on the horizon. Futures linked to the Fed’s key policy interest rate suggest traders are expecting around 100 basis points in cuts this year, compared to roughly 60 basis points anticipated for the European Central Bank.

Recent data from the Commodity Futures Trading Commission reveals that hedge funds and other speculative investors have shifted to a net short position on the dollar valued at $8.83 billion for the week ending August 27, marking the first bearish stance in about six months. This comes after a net long position of $32.6 billion in May.

"The recent dovish rhetoric from Powell indicates more cuts than previously anticipated," noted Aaron Hurd, a senior portfolio manager for currency at a prominent investment firm, who has recently adjusted his bullish outlook on the dollar.

The U.S. government’s jobs report for August, set to be released on September 6, may provide insights into any further weakening of what many policymakers describe as a still-robust job market.

SLOW DECLINE?

Several factors could inhibit a sharper decline in the dollar, at least in the short term. The sell-off in August, during which the dollar fell by 2.2%, has led some analysts to suggest that the U.S. currency may have slipped too quickly.

"While the Fed’s widely communicated rate cuts in September are likely to contribute to dollar weakness in the fourth quarter, the recent movements seem somewhat exaggerated," remarked Helen Given, an associate director of trading at a financial firm.

Despite this, the firm projects that the euro may reach $1.13 by June 2025, suggesting a slight decrease of about 2% against the dollar. Rose shares a similar view on this currency pair.

Many are waiting for more evidence of a slowdown in the U.S. economy before becoming significantly bearish on the dollar.

"The economy is decelerating, but it’s still in a very favorable position," said Thanos Bardas, co-head of global investment-grade fixed income at a major investment firm.

Speculation about the impact of the upcoming U.S. presidential election in November also looms. Polls indicate that leading candidates, Republican Donald Trump and Democratic Vice President Kamala Harris, are in a close contest.

Trump has criticized the strength of the dollar for negatively affecting U.S. competitiveness. However, many of his proposed policies, such as tariffs and tax cuts, could potentially bolster the dollar, according to Bardas.

Recently, Trump emphasized at an economic event that it’s vital for the dollar to remain the world’s primary currency, responding to questions about his approach to economic sanctions.

In contrast, Steven Englander, head of global FX research at a major financial institution, highlighted that a win for Harris could lead to increased taxes and intensified pressure on the Fed to accommodate if economic conditions worsen.

Ultimately, market reactions to potential reductions in U.S. interest rates are likely to be a key determinant of the dollar’s future direction, noted Kit Juckes, an FX strategist at a leading financial services firm. He remarked that strong growth has fueled significant foreign investment in the U.S., driven by yield-seeking foreign investors. However, as growth slows and rates decline, the ramifications remain to be seen.