What Does Fed Easing Mean for the USD?

With the recent 50-basis-point rate cut by the Federal Reserve, analysts at Bank of America have addressed client questions about its potential effects on the U.S. dollar (USD) and related historical precedents.

According to the bank, there are no direct parallels to the current economic situation. They note that while the economic environment shares some similarities with 1995—when the USD was considered undervalued—today’s dollar is deemed overvalued, complicating any comparative analysis.

Following the Fed’s decision, the USD initially fell but rebounded after Fed Chair Jerome Powell delivered an upbeat assessment of the economic outlook during a press conference. His view framed the rate cut as a “recalibration,” which contributed to the dollar’s stabilization.

Historically, the performance of the USD during previous easing cycles has been unpredictable. Bank of America highlights that the dollar has rarely strengthened during such periods, with 1995 being an exception due to its undervaluation. Presently, the USD is expected to gradually decline from its overvalued status, although this trajectory may not be linear.

Analysts also noted that the Fed’s current focus on employment suggests that more rate cuts could be on the horizon if labor market data deteriorates. Additionally, a more significant decrease in the USD would also rely on improved global economic conditions. However, at this time, the primary factors influencing the dollar continue to be U.S. interest rates and risk sentiment tied to economic data in the U.S.

As the easing cycle continues, the bank suggests that hedge funds may further reduce their long positions in the USD, or that institutional investors could rebuild short positions. Despite these dynamics, the analysts believe the dollar’s journey will be shaped by a mix of U.S. economic data and conditions in the global economy.