The factors that have explained the dollar’s strength during the last year and a half are still in place and do not look as though they will change in the short term. This is why the dollar continues to trade at the lower band of the 1.07-1.10 range, where it has been since the beginning of 2023.
First, US economic resilience has held up very well and, even though we have had a few signs of a weakening consumer, growth is still above that of the Eurozone where most recent PMIs have cast doubt on the improving economic situation of the region.
Second, the artificial intelligence boom headed by the Magnificent Seven explains most of the stock market’s positive performance. It has seen important foreign capital inflows, further driving the strength in the dollar.
Obviously, the snap parliamentary elections called by President Macron after the disappointing results obtained by his party in the European elections has also given support to the dollar. Not only due to the increase in volatility from political uncertainty, but also caused by the wake-up call on the fiscal situation of the euro area, as the European Union’s executive arm is considering opening “excessive deficit procedures” against France along with six other countries. With the left New Popular Front securing the surprise outcome of being the largest group in parliament, improving the fiscal situation of the country will be a tedious affair.
Finally, and probably more importantly, the US dollar is set to maintain its yield advantage. Indeed, at the last ECB meeting, official rates were cut by 25 bp, while in the US, the Fed decided to hold rates steady. The disappointing inflation data during the first quarter has delayed rate cuts until December according to the Fed dot plot, while consensus is more optimistic, expecting two cuts this year.
So, what could change the dollar’s strength? Probably much weaker US economic data, which would allow the Fed to lower rates at a faster pace.
Date of report: July 10th 2024