According to FactSet data, as of Wednesday, the dollar index fell by 0.54%, further expanding this quarter's decline of more than 4%. As a result, the dollar index has almost returned to its level at the beginning of the year. The index is used to measure the performance of the dollar relative to other major currencies.
George Saravelos, Head of Global Currency Research at Deutsche Bank, stated in an email on Wednesday: "Since August, market pricing has reflected that the Federal Reserve might be embarking on a significant easing cycle. By next year, the dollar may lose its status as one of the high-yield currencies. This would be a notable change, and in our analytical framework, it signifies a more bearish outlook for the dollar."
Saravelos further emphasized: "Therefore, for our medium-term view of the dollar, the critical question is: do we agree with current market pricing? We do not. As long as the dollar remains a high-yield currency, there are ample reasons to believe it will stay strong."
Deutsche Bank's research also shows that the performance of the U.S. economy exceeds the widely expected GDP growth, which forms a stark contrast with the situation in Europe.
Despite a slight rise in the recent U.S. unemployment rate, signaling a "loosening" labor market, Saravelos explained that the U.S. benefits from an influx of immigrants, noting: "If the primary driver is a positive supply shock, the economy could continue to expand even if the unemployment rate increases."
Saravelos also believes that the U.S. "terminal rate" is unlikely to be lower than countries with more severe supply chain issues (e.g., the UK). He also questioned whether the U.S. terminal rate would be lower than in countries facing recessions (e.g., New Zealand) or those where rates never rose significantly (e.g., Australia).
Moreover, Saravelos pointed out that U.S. fiscal policy appears likely to remain loose, regardless of the upcoming election results, and that the U.S. economy is less sensitive to changes in interest rates compared to other countries.
Investors widely expect the Federal Reserve to initiate rate cuts later this month. According to CME's FedWatch tool, as of Wednesday afternoon, traders in the federal funds futures market see a 57% chance of a quarter-point rate cut by the Fed, while the likelihood of a half-point cut is lower, at 43%.
Saravelos also mentioned that historically, the Fed has rarely cut rates by half a percentage point during or after "emergency meetings." If the Fed adopts a precautionary rate cut and swiftly begins a series of cuts, it could lead to a weaker dollar, as this would represent a policy shift by the Fed and reduce short-term interest rate differentials.
However, he also believes that a precautionary rate-cutting strategy might increase the likelihood of setting the terminal rate at a higher level, adding uncertainty to the dollar's medium-term outlook.
According to CME's FedWatch tool, as of Wednesday, the market expects the Federal Reserve's policy rate to drop to around 3% over the next 12 months. The Fed will conclude its two-day policy meeting on September 18 and announce the latest rate decision. Saravelos concluded: "The dollar's trend by the end of the year will depend on the specifics of the easing cycle the Fed is about to commence."
