The US dollar takes a big dive! Weak job data, market bets on the Fed to cut rates significantly

Zhitong Finance APP noticed that the US dollar has seen its largest decline since May, as the unexpectedly weak US employment report has exacerbated market concerns about the economic outlook, leading traders to bet that the Federal Reserve will cut interest rates by a larger margin this year.

The Bloomberg Dollar Spot Index plummeted by 0.7% on Friday, as the prospect of the Federal Reserve easing monetary policy and the sharp drop in US Treasury yields weakened the attractiveness of the US dollar. The yen saw the largest decline against major currencies, hitting its strongest week since 2022 after the Bank of Japan raised interest rates.

The decline in the US dollar highlights that investors are more focused on the relative trends of global central banks than the potential demand for the US dollar as a safe-haven currency, as concerns about the economy continue to escalate. Both the stock market and oil prices fell due to labor market data, and this volatile backdrop may support the euro.

Valentin Marinov, Director of Foreign Exchange Research and Strategy at Credit Agricole CIB, stated: "As US rate markets continue to bear the brunt of the Fed's aggressive easing policies, the dollar is indeed in an uncomfortable position." "This is eroding the dollar's exchange rate advantage and pushing down the dollar against other G10 currencies."

Previously, the US dollar was boosted for most of this year as the Federal Reserve kept benchmark interest rates at their highest level in over 20 years while the economy remained resilient. Friday's decline reduced the Bloomberg Dollar Spot Index's gain for the year to 3%, which is still slightly above the 200-day moving average.

In 2024, only one currency in the G10 rose against the US dollar - the pound, while commodity currencies and the yen lagged behind. The yen is still down nearly 4% against the US dollar this year. The currencies of commodity-exporting countries - Australia, Canada, New Zealand, and Norway - performed even worse, with declines ranging from 4% to 7%.

Bullish Outlook

For those bullish on the US dollar, if deteriorating market sentiment leads to an increased safe-haven demand for the US dollar as a major global reserve currency, market volatility and economic concerns could reverse the US dollar's trend.

Adam Farstrup, Head of Multi-Asset Americas at Schroders, said: "If we enter a global recession led by the US, we typically see the dollar weaken first and then strengthen."

While a US economic recession is not his base case at the moment, he noted that the likelihood of a US economic recession increased after Friday's data release.

If the Federal Reserve does not ease monetary policy as much as investors and economists currently expect, this would be another potential boost for the US dollar. On Friday, futures traders expected the Fed to cut rates by a full percentage point by the end of this year - with only three Fed meetings left in 2024 XTB's research director Kathleen Brooks said, "All factors originating from the bond market are driving the foreign exchange market." "From now until January next year, will the market be disappointed with the Federal Reserve? This will push the dollar higher."

In recent weeks, the bullish sentiment towards the dollar has waned, while expectations for the Federal Reserve to follow central banks such as the Bank of Canada, the European Central Bank, and the Bank of England in lowering borrowing costs have been increasing.

According to the data from the Commodity Futures Trading Commission as of the week ending July 30th, hedge funds, asset management companies, and other speculative market participants currently hold approximately $15 billion in bullish bets on the dollar. Although this position has increased compared to the previous week, it is still more than 50% lower than the approximately $33 billion in April.

Sophia Drossos, a strategist at Point72 Asset Management, said, "The economic data slowdown we are seeing challenges the exceptionalism narrative of the United States, which should be consistent with the reversal of the dollar against other currencies."