Dollar under pressure: no postponement

At the beginning of 2024, it seemed only a matter of time before the American policy rate would start to decline. It now appears that the first rate cut will not come until September. After a strong first half-year, the dollar may finally come under some pressure.

In recent weeks, currency markets had to quickly adjust to political surprises and developments on the interest rate front. After the elections in France and the United Kingdom, attention shifts to the interest rate decisions central banks have to make. Last Thursday, it was the turn of the European Central Bank. The focus is now mainly on the Federal Reserve of the United States and the Bank of Japan, which will make a decision just before the end of this month. The latter bank gave a hint of a policy shift two weeks ago by boosting the yen. Meanwhile, the United States has been following the motto 'the dollar is our currency, but your problem' for over fifty years.

Our currency, your problem
That statement made by then Treasury Secretary John Connally in 1971 could easily be repeated in the 'America First' era. The American central bank certainly does not consider currency effects when formulating its interest rate policy. In the past month, the dollar has dropped by over 2% to nearly its lowest level of 2024. Financial markets are preparing for the possibility that the policy rate in the United States may decline more sharply than anticipated earlier this spring. Fed Chair Jerome Powell recently told the U.S. Congress that the economy is no longer overheating and the labor market is cooling off. Instead of focusing on the risk of inflation, Powell also mentioned that the central bank is looking at the danger of an economic growth slowdown.

Reading between the lines
Reading between the lines, it quickly becomes apparent that Powell is leaving the door slightly ajar to give the economy a boost through a declining policy rate. He has this room because inflation has dropped from 3.4% to 3.0% over the course of the year. However, the chance of a rate cut this month is very slim. According to the FedWatch Tool, this chance is currently priced at less than 5%. However, this probability increases to over 98% for the Fed meeting on September 18. And by the end of this year, the policy rate is expected to be a whopping 0.75 percentage points lower than it is now, according to FedWatch. It is not wise, however, to blindly rely on such forecasts. The publication of economic data or political events could suddenly change the outlook.

Quick adjustments
In this last category, the election date of Tuesday, November 5 stands out, of course. With Joe Biden withdrawing last weekend and the attack on Donald Trump on Saturday, July 13, the chances of the former president may have increased. Although in theory, the dollar benefits from the policies Trump wants to implement, the currency actually slightly declined against the euro during his previous term. There is also the scenario where the Democratic Party puts forward a different candidate. Fortunately, currency markets have been able to practice quick adjustments between politics and economics in recent months.

Joost Derks

Joost Derks is a currency specialist at iBanFirst with over twenty years of experience in the foreign exchange market. This column reflects his personal opinion and is not intended as professional (investment) advice.

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