The US dollar slides towards the "smile curve", will it move to the left next?

In the first half of this year, the US dollar continued to strengthen along with strong economic performance. However, as the economy slows down and rate cuts approach, the outlook for the US dollar faces more uncertainty.

Since the third quarter, the US dollar has been the weakest performer among G10 currencies.

On August 22nd, Bank of America Merrill Lynch strategists Athanasios Vamvakidis, Paul Ciana, and others released a research report stating that the US dollar is currently in the middle of a "smile curve". Considering the "soft landing" of the US economy and the prospect of Fed rate cuts, they continue to be bearish on the US dollar for the second half of the year.

Continued Bearish Outlook on the US Dollar, Expecting 2 Rate Cuts by the Fed this Year

The report indicates that in the first half of the year, rate cut expectations by the Fed were repeatedly delayed due to strong economic growth and sticky inflation, which helped strengthen the US dollar. But now, with the US economy slowing down, the market has almost fully priced in an imminent Fed rate cut, leading to a continued weakening of the US dollar.

At the beginning of this year, with the unexpected "dovish" tone of the FOMC meeting at the end of December and strong rate cut expectations, the US dollar weakened. However, we believe that inflation remains sticky, interest rates will stay high for a longer period, and the easing cycle will be later and weaker than expected by the market, so we were bullish on the US dollar in the first half of the year - which has proven to be correct. In addition, the better-than-expected economic performance in the US also contributed to the dollar's rise.

Subsequently, with the US economy slowing down and rate cuts approaching, the US dollar has been weakening since the third quarter. It is expected that with the "soft landing" of the economy and Fed rate cuts, the US dollar will continue to weaken.

The report points out that the US dollar has now moved from the right side to the middle of the "smile curve".

The "smile curve" theory was proposed by former Morgan Stanley currency strategist Stephen Jen. According to this theory, the US dollar strengthens during periods of significant US economic decline or strong growth, but weakens during periods of broad global growth.

The middle stage of the "smile curve" implies that the US economy is neither strong nor in recession, hence the US dollar weakens.

The report also adds that the answer to the question of whether the US dollar will continue to shift left (global economic recession leading to a stronger US dollar) is negative - as economic data improves and recession concerns fade, boosting risk sentiment and thus bearish for the US dollar.

Bank of America stated that even if other central banks start cutting rates, it will not make the US dollar more attractive, as the impact of Fed rate cuts will be more profound. If unexpectedly strong regional economic growth occurs in the US, it will further bearish for the US dollar.

The report also predicts that the Fed will cut rates twice this year, and the current market pricing of four Fed rate cuts is too high