Expectations of interest rate cuts suppress the strong US dollar, and the Federal Reserve's policy direction may determine future trends

According to the Wisdom Financial News app, the upcoming Fed rate cut may end the long-standing strength of the US dollar, and the speed of the dollar's decline is accelerating. Data shows that the US dollar index has fallen by 5% from its 2024 high, approaching the lowest level in a year.

In recent years, the strong US economy and persistent inflation have kept the US federal benchmark interest rate far above other developed economies, making dollar-denominated assets more attractive. However, as inflation has cooled and signs of a slowdown in the labor market have emerged, Fed Chairman Powell sent a strong signal of a rate cut in September at last month's Jackson Hole Global Central Bank Annual Meeting, which is expected to weaken the strong momentum of the US dollar.

Brian Rose, a senior US analyst at UBS Global Wealth Management, said, "We have always believed that once the Fed starts cutting rates, the dollar will weaken regardless of other circumstances. We still hold this view."

Given the US dollar's central position in the global financial system, correctly understanding the dollar's trend is crucial for investors. A weaker dollar may make US exporters' products more competitive overseas and reduce the cost for multinational companies to convert overseas profits into dollars. In the long run, how much the dollar will fall may depend on the extent of the Fed's rate cuts in the coming months and the speed of rate cuts by other central banks.

Currently, the US economy seems stronger than many other economies. The spread between the 10-year US Treasury yield and the 10-year German Bund yield recently stood at 160 basis points, near the five-year average level of 167 basis points, despite narrowing in recent months.

However, investors are betting on significant rate cuts by the Fed in the future. Futures linked to the Fed's key policy rate show that traders expect the Fed to cut rates by about 100 basis points this year, while the ECB is expected to cut rates by about 60 basis points. Data from the US Commodity Futures Trading Commission (CFTC) tracking hedge funds and other speculative investors' positions showed that as of the week ending August 27, net short positions on the dollar were $8.83 billion, the first net short position in six months; in contrast, net long positions in May were $32.6 billion.

Aaron Hurd, Senior Portfolio Manager at Dodge & Cox Global Investment Management, said, "Powell's recent dovish tone suggests that the rate cut may be larger than initially expected." The US August non-farm payrolls report to be released on Friday may provide further clues about the job market. The market currently expects non-farm payrolls to increase from 114,000 in July to 160,000 in August, while the unemployment rate is expected to slightly decrease from 4.3% in July to 4.2% in August. Many policymakers believe that the job market remains healthy.

Slow Decline?

Several factors may at least temporarily prevent further decline of the US dollar. The US dollar index fell by 2.2% in August, and some strategists point out that the dollar may have fallen too quickly. Helen Given, Deputy Head of Trading at Monex USA, said, "While the long-term action starting in September by the Fed does indicate a softening of the dollar in the fourth quarter, the recent decline has been a bit overdone." Many are waiting for more evidence of a slowdown in the US economy before further bearish on the US dollar. Thanos Bardas, Co-Head of Global Investment Grade Fixed Income at Neuberger Berman, said, "Despite the slowdown in the US economy, it remains in a very healthy state."

In addition to the economic conditions, the outcome of the US presidential election in November may affect the fate of the US dollar. The Republican presidential candidate has expressed dissatisfaction with the strength of the US dollar, stating that it damages the country's competitiveness. However, Thanos Bardas pointed out that many of Trump's policies, such as raising tariffs and tax cuts, may actually strengthen the US dollar.

Steven Englander, Global Head of G10 FX Research at Standard Chartered Bank, noted that if the Democratic presidential candidate Harris wins, it could lead to higher taxes. If economic activity slows down, the Federal Reserve will face greater pressure to ease monetary policy.

Kit Juckes, FX strategist at Societe Generale, stated that ultimately, the market's reaction to a US rate cut could be the deciding factor in the direction of the US dollar. He mentioned that strong economic growth provides the US with an "insatiable appetite for foreign investment and foreign investors eager to chase yields." He added, "Now with growth slowing and rates falling, we will wait and see."