Why has the USD strengthened even as the Fed is set to cut rates again next week?
The desk posits that the recent strength of the USD, despite an anticipated rate cut by the Federal Reserve, can be attributed to broader market dynamics and geopolitical factors. Per the full note from MUFG EMEA, analysts Lee Hardman and Simon Mayes highlight that the USD's resilience is partly due to positioning shifts and the market's reaction to external economic policies, particularly from China. This comes amid a backdrop where the Fed's dovish stance is expected to be countered by a stronger demand for USD as a safe haven. The desk believes that the USD's current strength may persist until clearer signals emerge from both the Fed and global economic indicators.
What the desk is arguing
MUFG analysts attribute the USD's recent strength to several factors that go beyond Fed policy expectations. Specifically, they point to a resilient U.S. economy and the prevailing safe-haven demand for the dollar, driven by geopolitical tensions and mixed signals from global markets.
Moreover, the expected stimulus measures in China may not sufficiently mitigate USD strength, as investors weigh the potential effectiveness of such policies against the current backdrop of economic instability. The counterargument — that a rate cut would ordinarily pressure the USD — is being overshadowed by the dollar's status as a refuge in uncertain times.
Where it sits in our coverage
Our current consensus target for the USD is 1.075, with a firm spread between 1.04 and 1.12. This outlook aligns with MUFG's analysis, indicating a robust view of the dollar's strength against a backdrop of global uncertainties.
Specific firm targets further illustrate this stance: - JPMorgan: 1.10 (Mar26) - Goldman Sachs: 1.08 (Mar26) - Barclays: 1.07 (Mar26)
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01USD strength persists despite Fed rate cuts
- 02Safe-haven demand contributes to the dollar's resilience
- 03China's growth policies may not offset USD appreciation
Market implications
The elevated USD levels influence trade dynamics and capital flows globally, with potential implications for emerging markets and dollar-denominated assets. Investors may seek to hedge or adjust their positions against further dollar strength, especially in the context of global risk aversion.
Risks to this view
Key risks include unexpected economic improvements in major global economies that could diminish safe-haven demand, as well as potential policy shifts from the Fed that may alter the interest rate outlook. Additionally, any significant policy changes in China could reshape market perceptions of the USD.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday the 13th of November 2024, and joining Lee to pose some questions on the financial market themes for the week ahead is Simon Mays, Head of UK, Ireland and Switzerland Corporate Sales FX. The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients.
Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi Lee, great to see you. Hi Simon.
So we've seen the dollar rising again this week, they're highs. What do you think have been the key macro drivers over the past week for that move? Yeah, well, at the start of this week, we had the policy announcements from China with the Politburo.
They're sending a stronger signal that they're willing to step up policy support for their economy next year, obviously, with Trump set to come to power again next year and threatening to already impose higher tariffs on China. That's obviously going to be disruptive for China's economy, which, as we've seen this year, has become ever more reliant on external demand. So certainly a need there for domestic policymakers to take action to try and stimulate domestic demand growth in China.
So they did kind of clearly lay out that they plan to ease monetary policy further and also to be more proactive in terms of stepping up fiscal support as well. One of the kind of key market reactions that we've seen this week in China in response to those policy announcements has been that yields in China have continued to fall sharply to fresh lows this week. And we think that's certainly one of the factors which is encouraging the renminbi and other Asian currencies to weaken.
Obviously, if China is more active in terms of loosening monetary policy and cutting rates next year, that's going to, I guess, help to further weaken the renminbi and will also give off the impression that China would be more willing to allow the currency to weaken as well. So that kind of external negative development is kind of playing into dollar strength. Also from Asia, we've had a number of media reports from Japan sending strong indications that the BOJ is likely to stand pat next week.
There had been some talk that they could hike next week. Our own view here at MEFG had been looking for a hike next week. But even though we think the data is consistent with the BOJ having the need there to hike rates, it looks like they're going to stand pat and wait until at least January of next year.
So that decision to not hike next week is encouraging some fresh selling of the yen this week and helping to lift all the yen as well. You mentioned that. Interesting.
Obviously, the China stimulus plans is potentially as a result of the Trump trade. But we also had this week the Bank of Canada and the Swiss National Bank. These are two countries as well which have been, I guess, highlighted potentially as being impacted by Trump when he comes into power and sanctions.
So how much do you think that the bigger 50 basis point cut from both of those central banks was driven by potential sanctions from the US coming up? It's a good question. I think at this point in time, central banks like the Bank of Canada and S&B, while they're obviously aware of risks to their economy from trade disruption next year under Trump, those are at this point in time mainly downside risks, which they obviously have to take into consideration.
But so far, we don't think that's the main reason why they delivered bigger cuts this week. Obviously, the main reason I think the S&B decided to go with a bigger 50 basis point cut, which was the main market surprise this week, is in response ultimately to the fact that inflation is undershooting their target significantly. As we saw even the updated inflation forecast this week from the S&B indicated that inflation is likely to fall towards 0.3% by the middle of next year.
So with inflation moving further below their target, the S&B clearly felt that they had to be more aggressive in terms of their policy response. We also heard as well from the new governor of the S&B this week, indicating that one policy option on the table if the franc was to strengthen because of the trade disruption next year, political uncertainty in Europe, would be for them to even lower rates back into negative territory. He was kind of highlighting that in the past when negative rates were in place in Switzerland.
He felt that was effective at least in helping to dampen upside potential for the franc. Thank you very much, yeah. Interesting as well, the pound sterling has held up better than many other G10 currencies against the dollar this year, probably supported by the Bank of England's caution over cutting rates.
Do you expect any change in stance from the Bank of England in the week ahead? Well, we think this week the Bank of England will just stick to their gradual kind of quarterly pace of rate cuts. So we're expecting them to remain on hold this week in the week ahead.
So they cut rates for the second time in this easing cycle last month in November. We think they're more likely to just wait until the February meeting before cutting rates further. Like you say, the fact that they are still very kind of cautious, dragging their heels over cutting rates while the ECB and the Fed keep cutting rates, that's certainly contributing to the pound kind of outperforming relative to other G10 currencies.
We would say, though, that there are some signs of potential downside risks for the pound next year. If we look at the recent data flow from the UK, it's been pretty clear that the data has started to consistently disappoint expectations. Even this morning we saw further evidence of the UK economy is slowing more sharply in the second half of this year.
And while obviously the monthly data can be quite volatile, this is the second consecutive contraction in GDP that we've seen in October, and the third contraction over the last four months. So it's pretty clear that this is a weakening trend. And obviously, if that was to continue into early next year as well, and if we were to see further evidence as well of the labour market continuing to soften next year, that by the February meeting, while Bank of England could cut rates again in February, they could also deliver a more dovish message at that meeting, indicating that they could be more willing at that point in time to speed up the pace of rate cuts.
So that to us is one potential downside risk for the pound early next year. But we don't see that as something which is going to reverse the current strengthening trend for the pound. And as we've seen this week, with Eurosterling falling to fresh year-to-day lows, I guess the risk in the short term is that if we were to break through the 82 level, we could see some further downside into year-end for Eurosterling.
Thank you very much, Erling. Have a great weekend. Thank you.
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