Time to buy dollars, says BCA, ahead of Fed rate cut cycle By Investing.com

Investing.com — It snapped its four-week losing streak on Friday, and some believe the time has come to buy the greenback as this fighting spirit is set to continue.

“We have recommended a trading range in DXY between the 101 and 108 levels. DXY has recently entered our buy zone and we suggest it is time for investors to go long,” BCA Research said in a recent note.

The bullish outlook on the dollar has been throughout a history or cycle of rate cuts, the BCA notes, adding that the ebbs and flows in the foreign exchange market during a rate cut cycle are quite consistent.

The dollar has tended to be flat-down for most of the cycle leading up to the first interest rate cut by the Federal Reserve. But the dollar is now already at its lowest point compared to previous cycles, assuming the Federal Reserve begins cutting interest rates in September, suggesting that room for a significant decline could be limited.

“DXY’s median rally over the next 12 months after the Fed eases policy is 5%,” BCA added.

In previous tapering cycles, the Fed has cut interest rates by nearly 400 basis points on average over the 12 months after an easing cycle began. This time, however, the market is pricing in Fed rate cuts of about 200 basis points, or half the historical average.

“If our thesis is correct and the Fed does not cut rates by more than the markets are already pricing in, this bodes well for the dollar,” BCA said.

The divergence in monetary policy expectations between the US and other major economies is also expected to support the greenback.

“Our work (on the sensitivity of GDP to interest rates) suggests that policy is already very restrictive for the UK and the euro area. Thus, these economies are likely to witness a deeper recession compared to the US,” BCA said.

But not everyone is convinced that the dollar’s recent strength marks the start of an extended rally.

Sentiment against the dollar is already bullish, BCA says, as “most investors are already long the dollar”, risking a catalyst forcing a possible leveraged liquidation of long dollar positions.

“This catalyst will come in the form of higher equity prices, lower bond yields and low volatility,” BCA said, flagging volatility as a key metric to watch given its close correlation to the dollar.

“Among the measures we care most about, we will be watching volatility trends,” he added.