The Federal Reserve's interest rate cut in September is a foregone conclusion, and the market has already priced in nearly 200 basis points (BP) of rate cuts before the end of next year, leading to the US dollar index falling back to its beginning-of-year level, with the 100 mark imminently at risk of being broken.

Non-US dollar currencies are making a significant comeback, with the euro and the pound both hitting new highs against the US dollar for the year. The yen, which appreciated against the US dollar by more than 12% in early August, has continued to remain strong and is near its year-to-date high. As of 17:40 Beijing time on the 28th, the euro/dollar, pound/dollar, and dollar/yen were quoted at 1.114, 1.323, and 144.2, respectively, with the US dollar index at 100.75. Mainstream institutions believe that the weakening of the US dollar is still in progress.

Although the appreciation of the Chinese yuan is not as strong as some non-US dollar currencies, the cumulative appreciation of nearly 2000 basis points is already considerable, and the recent convergence of the spot exchange rate, the midpoint rate, and the offshore exchange rate indicates a significant decrease in depreciation expectations. Several Chinese and foreign institutional traders and analysts expect that the yuan is still likely to strengthen within the year, and the "exchange settlement wave" has not yet begun. Exporters who missed the previous round of high exchange settlements may take advantage of subsequent opportunities to settle. However, the extent of appreciation will still depend on the degree of improvement in the economic fundamentals. From the recent midpoint rate, the central bank has no intention of pushing the yuan to continue to appreciate.

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Barclays' foreign exchange and interest rate strategist, Zhang Meng, told Yicai: "We estimate that Chinese enterprises hold about 50 billion US dollars in deposits, and we believe that up to 10 billion to 20 billion US dollars may be exchanged for yuan after the offshore yuan breaks through 7.1."

The rate cut signal ignites the "weak dollar trade"

The Federal Reserve has begun to shift its focus from inflation to employment. Federal Reserve Chairman Powell stated at the Jackson Hole Global Central Bank Annual Meeting that "the time for policy adjustment has come," leaving only the question of whether there will be a 50BP rate cut in September and how much the rate cut will be for the year.

Traders quickly absorbed this signal and significantly pushed down the US dollar during the annual meeting, causing the US dollar index and US Treasury yields to plummet in the short term.

Standard Chartered's Global Chief Strategist, Eric Robertsen, told reporters: "Our view is that there will be a 25BP rate cut at each of the remaining three FOMC meetings in 2024, but if the US economy significantly deteriorates thereafter, it will open the door for a 50BP rate cut. The core PCE has already fallen to 2.6% year-on-year, and the unemployment rate has risen from 3.7% to 4.3% since the beginning of the year. If either trend accelerates substantially, the Federal Reserve may implement a 50BP rate cut."

Since August, the US dollar index has continued to decline, with non-US dollar currencies hitting new highs in stages. "After breaking through the important upward trend support last week, the US dollar index quickly weakened, falling to 100.6 at one point. With technical indicators such as RSI and MACD issuing bearish signals, the 50-day moving average crossed the 200-day moving average from above, and the death cross is looming. Coupled with the fact that important economic data will not be released until the latter half of the week, the current momentum is entirely favorable for the bears," said David Scutt, a senior strategist at Gain Capital Group, to reporters.

In his view, if the expectation of rate cuts cannot be further increased, the US dollar index is expected to find support near the 100 mark, which is the previous low and where the 200-week moving average is located. However, if it further breaks through the above-mentioned key support level, it may test the 96 level.However, several institutions have also warned that the current market may have overpriced the possibility of interest rate cuts, and it is necessary to be vigilant against a subsequent rebound in the US dollar from an oversold position.

Scott said that, according to federal funds futures, the market has already factored in the risk of a "hard landing," expecting more than 100 basis points in interest rate cuts over the next three meetings. This implies that there will be at least one 50 basis point rate cut within the year, with a smaller chance of two 50 basis point cuts. In addition, the market anticipates that there will be a 25 basis point rate cut at every meeting before September next year, a view that can be said to be a balance between pricing in a "hard landing" and a "soft landing." How market pricing evolves will have a significant impact on the broader performance of the foreign exchange market next year.

Salman Ahmed, Global Macro and Strategic Asset Allocation Director at Fidelity International, told reporters: "Unless the US unemployment rate rises significantly again in August, the first step should be a 25 basis point rate cut. According to our assessment, the US labor market has indeed slowed down, but it has not cooled rapidly. We still maintain the basic assumption that the Federal Reserve will cut rates by 25 basis points in September and again in December."

Before the September interest rate meeting, the most critical data will be the August non-farm employment figures due out on September 6th, and the July PCE price index to be released this Friday (August 30th). However, the latter is unlikely to change the rate cut tone that Powell has just set, unless the core PCE rises significantly from 2.6% to around 3%.

Momentum remains after non-US dollar currencies hit new highs.

Despite uncertainties, the market continues to bet that the trend of a weaker US dollar has not ended.

In the past month, the US dollar has depreciated nearly 3% against the euro, reaching a new low in over a year; the British pound has risen above 1.32 against the US dollar, reaching the highest level since March 2022. Over the past three weeks, the Australian dollar has rebounded 7% against the US dollar, jumping from the year's low to the year's high. The yen has appreciated more than 7% against the US dollar in a month. Gold also took advantage of the situation to reach a new high of $2531 per ounce on Tuesday (27th) this week.

The subsequent trend of the yen is the most closely watched by the market. The US dollar/yen once touched a high of 162, but reversed due to the Bank of Japan's unexpected interest rate hike and signal of balance sheet reduction, with carry trade unwinding pushing the US dollar/yen to around 140, and recently returning to around 144. However, expectations for the yen's appreciation still exist.

The direction of the yen also has a leading effect on the Chinese yuan exchange rate, as both are low-interest currencies in Asia and are easily affected by carry trades.

A series of data points to the possibility that Japan may continue to raise interest rates. According to data released by the Japanese Ministry of Internal Affairs and Communications last Friday (23rd), the CPI excluding fresh food in July rose 2.7% year-on-year, higher than the 2.6% increase in June, which is the latest sign of rising living costs. Subsequently, a speech by Bank of Japan Governor Haruhiko Kuroda caused the yen to rebound quickly. He stated that if inflation and economic data continue to align with forecasts, the Bank of Japan will continue to raise interest rates.The Oxford Economics Institute predicts that the Bank of Japan may implement additional interest rate hikes in October, following the hawkish forward guidance issued at the July meeting. "After another rate hike, we expect the Bank of Japan to be more cautious, raising rates only once in 2025 and 2026 to reach a terminal interest rate of 1%," the institution believes that the successor to Japanese Prime Minister Fumio Kishida in September will be revealed, and political support for the strength of rate hikes may weaken. Although the unpopular yen weakness, currently not favored by the public, has eased, politicians may be more concerned about the potential for a stock market pullback and the impact on vulnerable groups, including families with limited income and micro-enterprises.

Scott told reporters that if the US dollar/yen breaks the support level of 143.63, it will open up the imagination for a retest of the low point of 141.70 on August 5. In addition, 140.27 and 138 are also key downside levels to watch.

UBS forecasts that the exchange rate of the US dollar to the yen will be 147 in September and December of this year, and 143 and 140 in March and June of 2025, respectively.

The "exchange tide" of exporters may begin

In addition to the US dollar, yen, and other overseas factors, for the renminbi, the more critical factor is the behavior of exporters. In the past two years, Chinese companies have retained a large amount of high-interest US dollar deposits.

JPMorgan estimates that the total amount of US dollars not settled by Chinese companies has reached a level of 300 billion to 600 billion US dollars. Once the US dollar interest rate cuts and the exchange rate falls, these companies may settle in a concentrated manner, which could have a significant impact on the market.

"As far as we understand, not many export companies have settled recently, and most have not yet come out, having missed the previous wave. During this period, it is mainly the banks' proprietary trading that is taking place," said a financial market business person in charge of a foreign trade company to First Financial.

Barclays estimates that Chinese exporters hold about 50 billion US dollars, and if the US dollar/ offshore renminbi continues to weaken below 7.1, the institution expects that up to 10 billion to 20 billion US dollars may be exchanged for renminbi.

"In the past two years, Chinese exporters have not sold their US dollar income. Unlike companies in South Korea or Taiwan, which settled at high exchange rates (US dollar to Korean won above 1380, US dollar to New Taiwan dollar above 32.8), these exporters' pessimistic sentiment towards the renminbi has kept them holding US dollars," said Zhang Meng.According to China's foreign exchange settlement and transaction data, Zhang Meng estimated that from 2020 to 2022, the ratio of net foreign exchange settlement (on behalf of clients) by banks to China's annual commodity trade surplus averaged 0.29. However, in the first half of 2023, this ratio dropped to -0.17. Assuming that this "missing" settlement flow is mainly driven by exporters retaining US dollars, it is estimated that exporters have held about $538 billion since 2023. At the same time, based on the ratio of the total of foreign exchange derivative transactions and spot foreign exchange transactions published by the State Administration of Foreign Exchange, the average foreign exchange hedging ratio of Chinese enterprises in the first half of 2024 was 27.1%. Although this ratio is slightly higher than 24.2% in 2023 and 25.8% in 2022, it is still relatively low overall, indicating that exporters are more vulnerable in the face of significant foreign exchange fluctuations.

Institutional sources also told reporters that unless the Federal Reserve initiates an aggressive interest rate cut cycle, Chinese enterprises will continue to hold US dollars. In view of the recent increase in foreign exchange volatility, large Chinese enterprises are negotiating with their global partners to reduce foreign exchange risks, while small and medium-sized enterprises are reallocating resources by increasing overseas investments to reduce the impact of RMB fluctuations.