Fed strength on dollar could peak soon: Barclays By Investing.com

Investing.com — As the U.S. Federal Reserve nears a key turning point in its tightening cycle, frequency on the reserve may soon peak.

Analysts at Barclays suggest that while further dollar weakness is possible, the worst of the dollar’s depreciation is likely behind us.

The evolving outlook for US monetary policy, along with global economic conditions, point to a more stable dollar in the coming months, even as the Fed’s rate-cutting cycle begins.

Over the past few months, market participants have increasingly weighed in on the likelihood of earlier and faster rate cuts by the Fed. These expectations were driven by the perception of a slowdown in the US economy and the smooth changes of the Fed.

Final real rates, which reflect where the market expects the Fed’s tightening cycle to end, have fallen from nearly 200 basis points at the start of the summer to below 50 basis points in recent weeks.

Despite this downward shift in rate expectations, Barclays analysts believe most of the dollar’s depreciation has already taken place.

which tracks the dollar against a basket of major currencies, has been in decline since mid-2023. However, the pace of further depreciation is expected to slow as the Fed’s monetary tightening cycle draws to a close.

“That said, most of the dollar’s weakness tends to occur ahead of Fed easing cycles, and the move was already sizable by historical standards,” the analysts said.

The dollar typically falls shortly after the first cut as the market begins to reassess the economic outlook. This pattern is playing out again, the market is already pricing in future cuts and causing the dollar to weaken accordingly.

However, as the rate cut cycle progresses, the market often corrects its expectations about the depth of cuts. If the US economy avoids a severe recession, the Fed could cut rates more cautiously than expected, which could lead to a stabilization or even a rebound in the dollar.

In milder economic slowdowns, the dollar tends to recover once the market realizes that the Fed is not cutting as aggressively as feared.

Barclays points out that several factors could limit further depreciation of the dollar. One consideration is the possibility of a US recession.

If the economy slips back into recession, the dollar may strengthen as investors typically seek the safety of US assets during times of global uncertainty.

In this risk-averse environment, the dollar’s safe-haven status could once again come into play, particularly against emerging market currencies.

In addition, geopolitical factors, including ongoing tensions in Europe and China, could provide support for the dollar.

Barclays points out that risks related to US-China trade relations and concerns about European political stability could prevent the dollar from weakening further.

The upcoming US presidential election also raises the possibility of changes in trade policy, which could introduce new volatility to global markets, indirectly supporting the dollar.

China’s economic slowdown presents another key factor. As China’s growth continues to slow, driven by a waning credit drive and weakening consumption, the outlook for the Chinese remains bleak.

A weaker yuan could provide additional support to the dollar, particularly against Asian and emerging market currencies. Barclays notes that as China’s credit impulse fades, it tends to correlate with a stronger dollar.

Barclays forecasts some further USD depreciation in the near term as the market continues to price in Fed rate cuts.

However, the extent of further weakness is expected to be modest, with most of the dollar’s decline already behind it.

As the Fed’s rate-cutting cycle progresses, the dollar may begin to recover, especially if economic data points to a softer-than-expected decline.

“Our new forecasts call for further USD depreciation in Q4 24, but a rebound thereafter,” the analysts said.

This recovery could be driven by a recalibration of market expectations of Fed rate cuts alongside improving global risk sentiment.

Barclays suggests that while bouts of volatility are still possible, the dollar’s overall downtrend may be coming to an end.