Further dollar weakness is not a given, EURUSD outperforming fundamentals: UBS By Investing.com

Investing.com — The US dollar weakened this week as equity markets rebounded from early August declines, while expectations for a more accommodative Federal Reserve persisted.

Analysts at UBS Global Research caution against assuming a sustained decline in the US dollar. Although the euro has reached a new high against the US dollar in 2024, the rise may be overextended relative to economic fundamentals.

rose sharply on improved risk sentiment and a partial recovery in equity markets as losses from August were regained and volatility indices such as the decline.

Despite this increase, US yields have rebounded only modestly, and market prices suggest Fed rate cuts of nearly 100 basis points (bp) this year, including a possible 50 bp cut in September.

This market positioning indicates that further significant dollar weakness could face major obstacles, particularly with expectations for Fed policy already largely priced in.

“Recent price action raises the question of whether the market is finally shifting to a broadly bearish USD view and whether the greenback is on the verge of significant further weakness,” analysts at UBS Global Research said.

Although the Fed appears poised to ease policy, possibly with a 25bp cut in September, aggressive market expectations may leave little room for convenient surprises. Any positive economic data from the US, such as a rebound in non-farm payrolls (NFP), could lead to a tactical recovery in yields and the USD.

Analysts also signal that the broader global economic outlook remains uncertain, with limited signs of improvement outside the US. China’s stimulus efforts have yet to convince markets, and the eurozone continues to face downward revisions to growth forecasts. These factors reduce the likelihood of a significant move away from the dollar and US assets.

EURUSD’s recent rally, breaking past highs, is seen by UBS analysts as an overshoot from near-term fundamentals. The brokerage’s model estimates fair value for EURUSD closer to 1.0950, below current levels.

The deviation suggests that the pair is pricing in either unexpected US weakness or excessive optimism about Europe’s economic outlook. However, UBS remains skeptical of the eurozone’s growth outlook, pointing to negative economic surprises and headwinds in major economies such as Germany.

With these considerations in mind, analysts believe that EURUSD may struggle to maintain levels above 1.11 for an extended period of time, especially if upcoming data from the Eurozone falls short of expectations.

UBS analysts also discuss other major currencies, noting that recent moves in the Japanese yen and Swiss franc reflect global risk sentiment more than fundamental changes.

Morgan Stanley expects the Bank of Japan to maintain a cautious approach, which could lead to a rebound, providing a better entry point for shorts. Meanwhile, they see limited downside for the Swiss franc and expect it to remain range-bound near current levels.

In the Scandinavian region, UBS analysts favor the Norwegian krone over the Swedish krone, citing a more constructive central bank outlook in Norway. They recommend maintaining a short position in , predicting that the NOK’s recent rally is more sustainable compared to the SEK’s recovery.