(Bloomberg) – Maybe it was the week that broke the dollar.
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The greenback’s worst slide since November has a crowd of strategists and investors believing that a turning point is finally upon us for the world’s main reserve currency. If they are right, it will have far-reaching consequences for the global economy and financial markets.
The US currency is hovering at its lowest level in more than a year after signs of slowing inflation fueled speculation that the Federal Reserve will soon stop raising interest rates. Dollar bears are looking even further into the future for what they call inevitable rate cuts, something the market consensus expects sometime in 2024.
“Our call for the dollar to enter a multi-year downtrend is based in part on the fact that the Fed’s tightening cycle will turn into an easing cycle, and this will drag the dollar lower even as other central banks also cut rates,” Steven Barrow, head of G-10 strategy at Standard Bank, said in a statement on Friday.
Bloomberg’s dollar rate was little changed in early Asian trade Monday. Last week the price fell 2%, the sharpest weekly drop in the five days ended November 11th.
It’s hard to overstate the potential impact of a long-term dollar decline. It would lower import prices for developing countries and help ease their inflationary pressures. A reversal in the dollar would also strengthen currencies like the yen, which has been weak for months, and upend popular trading strategies tied to a weaker yen. More broadly, a weaker US currency would tend to increase exports by American companies at the expense of their competitors in Europe, Asia and elsewhere.
The story goes on
The 2% drop in the Bloomberg Dollar Index last week also contributed to gains in greenback-priced commodities such as oil and gold.
Many investors have been waiting for months for the dollar to trend lower, and the sell-off is leading fund managers from M&G Investments to UBS Asset Management to brace for currencies like the yen and emerging market currencies to outperform.
“The most likely way forward is for the dollar to remain weak in the coming months,” said Peter Vassallo, fund manager at BNP Paribas Asset Management. He bets on gains for the Australian dollar, New Zealand dollar and Norwegian krone.
What Bloomberg strategists say:
The prevailing dollar downtrend should remain intact while the real yield curve flattens. For example, one of the best leading indicators for the dollar is the real yield curve. The intuition is that the dollar is marginally driven by the real return of foreign investors in US yields.
– Simon White, Macro Strategist.
Of course, there’s a long history of investors getting burned by hasty bets on Fed rate cuts that would send the dollar lower. That was the case earlier this year when the currency appeared to be on the brink of a sustained downtrend, which then stabilized as US economic data made it clear that the Fed wasn’t ready to stop raising rates.
There is a risk for the bears that the momentum will repeat itself, especially as the Fed is likely to tighten further already this month.
At Invesco Asset Management, Georgina Taylor is not yet ready to reduce her dollar exposure. Still stuck in data watch mode, it is not yet ready to conclude that the battle to contain inflation is over.
“The history of the interest rate differential is changing, but I wouldn’t give up on the dollar,” she said, given that the absolute real yield differential remains wide.
The resilience of the US economy is why Goldman Sachs Group Inc.’s Michael Cahill believes the dollar’s decline is likely to be shallower than in past cycles. However, support for the dollar could collapse if the Fed calls for an end to its inflation war, even as the European Central Bank is forced to keep rates higher for longer.
“The biggest risk that could cause the dollar to move further down is that the inflation picture diverges,” said Cahill, a G-10 foreign exchange strategist. The bank forecasts that the dollar will weaken to $1.15 per euro in 2024 from currently around $1.12 to $1.15 and that the yen will appreciate to $125 per dollar from currently around $139 .
Dollar bears can also rely on valuation metrics. The currency’s strength has been particularly pronounced against the yen, with the real effective exchange rate taking Japan’s foreign exchange trading to its lowest level in decades.
“From a valuation perspective, the dollar is still grossly overvalued,” said Paresh Upadhyaya, director of currency strategy at Amundi Asset Management. “I think the markets will start to fade this.”
He points to the US’s twin deficits – its trade and fiscal deficits – as structural headwinds. But he also thinks of another dynamic that market watchers often cite: the dollar smile theory.
Read more: Wall Street is accepting the dollar smile theory at a breakneck pace
The greenback is thought to typically appreciate when the US is in either a severe downturn or a strong rebound – and falter during periods of moderate growth.
“If the US pulls off a soft landing, that’s probably the best reason for a weaker dollar anyone could wish for,” Upadhyaya said.
– With the support of Nour Al Ali.
(Updates with early market action in the fifth paragraph. Corrected an incorrect chart in a previous version.)
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