In 2020, the Federal Reserve's emergency rate cut led to a more than 13% decline in the US dollar index within just nine months. Following Powell's hint last week about the potential for rate cuts, the US dollar index fell to a new low for the year, approaching the 100 mark.

Looking back at history, easing cycles often coincide with a weaker US dollar, but the impact of various factors such as macroeconomic trends, interest rate paths, and capital flows on exchange rate movements should not be overlooked.

The US dollar may digest the bearish impact in the short term

The trajectory of the US dollar is often closely related to Federal Reserve policies. This year, the US dollar has shown a pattern of rising and then falling, with concerns about policy tightening due to rebounding prices, leading the US dollar index to break through the 106 mark in mid-April. After key inflation indicators remained flat in the second quarter due to deflation in commodities and a slowdown in rent, the US dollar index has fallen nearly 4.8% since the second half of the year.

Advertisement

Non-US currencies have rebounded significantly; this week, the British pound reached 1.3250 against the US dollar for the first time since March 2022, the euro against the US dollar hit a 13-month high, and the Japanese yen has rebounded nearly 12% from its low point of the year.

BK Asset Management's macro strategist, Boris Schlossberg, said in an interview with Yicai that the key conclusion from Powell's Jackson Hole speech was that as the price situation progresses, the Federal Reserve has shifted its focus to the job market, trying to avoid further deterioration. Of course, the Federal Reserve has not released more information at present, and the outside world can only gauge the strength of policy easing by measuring economic conditions from more data.

Bank of America believes that after the recent decline, the US dollar index is close to its fair value for the first time since March. Bank of America's rate and currency analyst, Adarsh Sinha, said that one of the reasons the US dollar index was overvalued before was that it benefited from the market's low volatility, which encouraged those seeking higher interest rates to flow into the US dollar. "Since then, the volatility caused by concerns about a US economic recession and the increased volatility due to position unwinding has greatly reduced this overvaluation."

As of last weekend, the gap between the US dollar index and Bank of America's pricing model fell within 0.4%, with model-driven factors including global macro, Federal Reserve policy, energy prices, and global stock markets. "This is not the most compelling reason for investors to downplay the selling of the US dollar, but it does indicate that overvaluation will not be as much of a headwind for US dollar bulls as it was a few weeks ago," the report said.

Schlossberg told Yicai that he believes the US dollar has already digested the pricing of a 25 basis point rate cut in September in the short term. Regarding the policy easing space of more than 100 basis points in interest rate futures within the year, he thinks it is still too early to say. If the August non-farm data does not surprise, the Federal Reserve will continue to be patient and communicate with the market in a timely manner. From this year's situation, market forecasts are often continuously calibrated.

The pace of rate cuts is important.Historically, the trend of the US Dollar Index during interest rate cuts has often been quite varied.

Societe Generale analyst Kit Juckes has analyzed the relationship between the US Dollar Index and the federal funds rate over the past forty years. In 1985, the US Dollar Index began to decline four months after the first interest rate cut, while in 1998, 2000, and 2007, the index had already weakened before the start of the rate cut cycles. It is worth noting that during the rate cut cycles in 1996 and 2005, the US Dollar Index experienced short-term rebounds.

Societe Generale believes that, historically, strong rate cut cycles may weaken the US dollar. In contrast, for weak rate cut cycles, as funds flow into US assets, there may not be much reaction to the strength or weakness of the dollar. The current cycle of the US Dollar Index is slightly lower than in the 1980s and early 2000s, when the dollar subsequently weakened significantly amid recession and substantial rate cuts by the Federal Reserve.

Last week, the US Department of Labor revised down the total non-farm employment numbers for the period from April 2023 to March 2024 by 818,000. Previously, the US unemployment rate in July rose to a near three-year high of 4.3% amid a significant slowdown in hiring, raising concerns about a worsening labor market and potentially making the economy vulnerable to a recession.

Although the US economy is widely expected to cool in the second half of the year, debates on a hard landing on Wall Street continue. Earlier this month, JPMorgan Chase increased the likelihood of a US recession before the end of the year to 35%, citing increased pressure on the labor market, while Goldman Sachs reduced the probability of a recession in the next 12 months to 20%.

UBS Global Wealth Management has raised the likelihood of a US recession from 20% to 25% this week, citing weak job growth and July unemployment data that have sparked concerns about a recession.

UBS Senior US Economist Brian Rose stated that the excess savings accumulated during the pandemic have been depleted. "Sustained income growth is crucial for maintaining expenditure growth, as a stable savings rate may be the best outcome we can hope for."

BlackRock believes that the overall US economy is expected to slow down rather than go into recession, especially after observing that US corporate earnings (particularly in the technology sector) have been stronger than expected. "Stronger-than-expected US corporate earnings, especially from technology companies, reinforce our optimistic view of the US economy. So far, the earnings growth rates for technology and non-technology stocks in the second quarter are 20% and 5%, respectively, higher than the 18% and 2% expected at the start of the earnings season."