The dollar has more downside as the Fed moves closer to tapering

Investing.com – The US dollar has had a difficult summer so far, and Capital Economics sees more declines over the next two years, citing unfavorable rate differentials and continued robust risk appetite.

The dollar index, which tracks the greenback against a basket of six other currencies, has fallen about 4 percent since July as weaker-than-expected activity and inflation data prompted markets to reassess the path of interest rates in the U.S. and elsewhere .

“With the Fed finally set to begin easing policy and a soft landing still looking the most likely outcome for the US economy, we believe unfavorable interest rate differentials and continued risk appetite will lead to further US dollar weakness in the next couple. years,” analysts at Capital Economics said in an Aug. 21 note.

The index is at its lowest level since the end of December 2023, although still quite strong in a long-term perspective. With Fed rate cuts now around the corner, the key question is whether that means the dollar’s recent weakness must continue.

Evidence from the seven monetary easing cycles of the 1970s shows that the dollar strengthened for at least a year after the Fed Funds rate peaked five times after a peak in short-term rates—though in three of those cases , the dollar fell substantially. later.

In only two episodes has there been a peak in the Fed Funds rate followed by a drop in the dollar. The main reason for this pattern is that Fed easing has most often come in the context of a weaker global economy.

Capital Economics believes the Fed will cut rates by more than most of its peers, meaning short-term interest rate differentials will continue to shift against the US.

“This suggests the dollar will weaken further,” Capital Economics added.