July’s disappointing labor market data led the Fed to initiate the easing cycle with a jumbo 50bp cut. Moreover, it indicated more cuts to end in the 2.75%-3.00% range in 2026. Markets are pricing even more aggressive cuts. All this explains why the dollar weakened 4% during the third quarter.
We believe that the dollar will recover some of its lost ground for several reasons:
First, even though the US economy is slowing, it is holding up much better than anticipated. The magnitude of rate cuts the market is forecasting is synonymous of a recession. This would not be the first time the market and the Fed have had to revise their interest rate forecasts.
Second, the US economy is more robust than the eurozone where the 2 major economies are facing several problems. In Germany the manufacturing and construction sectors along with household consumption is showing little signs of revival. And France, in midst of political uncertainty, must solve a growing deficit. Be it through spending cuts or tax increases, economic growth will feel the bite.
Finally, with markets at all-time highs and plenty of reasons for volatility to rise, the dollar as safe haven asset will appreciate should markets correct.
Date of report: October 7th 2024