The Fed is getting closer to cutting interest rates, but the dollar hasn't lost yet?

Daragh Maher, the head of FX strategy for HSBC in the United States, said that even if the Fed starts cutting rates later this year, the strength of the US dollar will prove to be resilient.

In an interview on Thursday, he said he expects the dollar to remain near its current levels by the end of 2025.

This is because HSBC expects the US economy to continue to outperform its global peers, and even if the Fed cuts borrowing costs by the end of the year as planned, the yield advantage of US Treasuries will persist.

Before his remarks, the CPI report showed a broad-based cooling of US inflation last month, leading to lower US Treasury yields and a weaker dollar as traders bet that the Fed would cut rates at least twice this year.

Maher said, "This theme of the 'American exceptionalism' still seems to closely follow the dollar. The bigger question is - can other countries in the world catch up?"

He predicts that the US Dollar Index (DXY) will reach 105 by the end of 2025, compared to around 104.5 now. Maher also expects the US dollar to slightly rise against the euro and the pound in the coming months.

On Thursday, the US Dollar Index fell by about 0.6%, marking its largest single-day decline in about a month, reducing the index's gain for 2024 to around 2%. Since the beginning of the year, as other central banks began easing policies, the Fed's "higher for longer" signal has supported the dollar.

The performance of the dollar this year is mainly influenced by interest rate expectations. The chart below shows the trend of the weighted average of the 5-year government bond yield differentials against the US dollar exchange rates with other major currencies.

This can also be seen in the returns of the dollar against other major currencies. The dollar has risen strongly against the yen this year due to the widening US-Japan interest rate differential, while it has fallen against the pound as its interest rate differential changed the least.

Karen Reichgott Fishman, senior currency strategist at Goldman Sachs, pointed out that in 21 out of 27 weeks this year, the correlation between stocks and bonds has mostly been positive, often coinciding with dollar volatility. Typically, when stocks and bonds rise simultaneously, the dollar struggles. "This makes the dollar's new highs this year even more surprising and strengthens the potential for tactical selling," she said.

Reichgott Fishman added that in an environment where US Treasury yields fall and stocks rise, the dollar usually weakens against most currencies, making it a good choice for funding arbitrage trades in emerging markets.

However, she emphasized that a dollar bull market may reappear in the second half of the year. The possibility of the US imposing tariffs before the election could bring upside risks to the dollar, especially against Asian currencies