Interest rate cuts meet elections, where will the US dollar exchange rate go? This is how Wall Street fund managers see it

All signs indicate that the next few months will be challenging for investors in the US dollar. Previously, the US presidential debate and key inflation data led the market to expect increased volatility by the end of the year.

Foreign exchange managers are working to cope with a series of dazzling uncertainties that could further exacerbate exchange rate volatility. With the Fed expected to cut interest rates next week and the US election approaching, an indicator measuring the three-month implied volatility of the dollar has reached its highest level since the regional banking crisis in early 2023.

Fund managers say the key is to determine the Fed's action trajectory, as they expect the Fed to be a major driver of the dollar. However, they also need to figure out whether the market has already digested the Fed's relatively loose policy compared to other major central banks, and how to position themselves around the November US election. At the same time, fund managers must also deal with a series of escalating geopolitical tensions that could impact the market in unpredictable ways.

Kestra Investment Management's portfolio management director Derek Schug said, "It is difficult to predict short-term exchange rate trends. We are preparing for the extremely unstable trend of the dollar for the rest of this year."

After the end of the US presidential debate on Tuesday, the dollar edged lower, with traders further unwinding bets related to former President Trump defeating Vice President Harris in November. Currently, the dollar has not recovered much ground from its sharp decline in August, which reduced its gains for the year by more than half. The market expects the Fed to cut interest rates by around 100 basis points by the end of the year, even after the unexpected rise in core inflation in August, making speculative investors the most bearish on the dollar in over a year.

Here are some comments from Wall Street fund managers on their expectations for the dollar in the coming months:

XTB Research Director Kathleen Brooks

Data shows that XTB was the most accurate forecaster of major currency exchange rates in the second quarter.

Brooks said, "Undoubtedly, the primary factor driving the dollar higher will be relative interest rate differentials. The outlook for the dollar for the rest of the year may really depend on the coming weeks."

Brooks noted that any reduction in bets on Fed rate cuts could give the dollar some breathing room. She added, "I don't think the election is a key factor for the currency market yet. We are on the brink of monetary policy changes, which are currently much more important to the market than political factors."

Regarding dollar trading, Brooks pointed out, "Forex volatility has been lower than any other asset class this year, but you can see the dollar gradually rebounding by 2.5%. So, against which currency pairs is the dollar rebounding from? The yen and the euro." However, she expects the euro to fluctuate between 1.11 and 1.08 against the US dollar in the next three to six months, currently around 1.10.

Kristina Campmany, Senior Portfolio Manager of the Global Debt Team at Invesco

Campmany, who manages $6 billion in assets, stated: "With the Federal Reserve about to start a loose cycle, whether it is a mid-term adjustment or a more significant neutral easing, the dollar may be in a more sustained weak state in the future."

Campmany believes that such adjustments could lead to a maximum devaluation of the dollar by 5%, or if the Fed's loose policy remains at a neutral level, a maximum devaluation of 10%.

Regarding dollar trading, Campmany pointed out: "In the past year, arbitrage trading in a relatively efficient manner has been possible, and we believe that this situation will continue as long as global economic activity remains strong." Arbitrage trading involves investors borrowing funds where interest rates are low and investing where rates are higher.

Invesco favors higher-yielding currencies such as the Mexican peso and the Brazilian real, while noting the special pressures these currencies have recently faced. They prefer to finance these positions through the US dollar as the base currency, as well as the euro, Chinese yuan, and Swiss franc.

Meera Chandan, Co-Head of Global Currency Strategy at JP Morgan

Data shows that JP Morgan was the runner-up in forecasting major currency exchange rates in the second quarter.

Chandan's key points on the future of the dollar: "The dollar is currently dividing the currency market into two parts, low-yield and high-yield. When US interest rates rise, the most severely affected currencies - low-yield currencies - may receive the strongest support when rates fall."

Chandan states that the dollar's performance will ultimately depend on the US economic growth outlook. "This does not even take into account the impact of the US election."

Regarding dollar trading, Chandan believes: "We have a defensive bullish view on the dollar. We still expect the dollar to strengthen, but this is different from the dollar strength we have seen in the past few years. Support for the dollar may come from safe-haven trades rather than outstanding US economic performance and high yields."

She said that in an economic recession, the dollar to yen exchange rate could fall below 135, even below 130, with the current exchange rate around 1 dollar to 142 yen. However, she pointed out that the dollar could still strengthen as all cyclical currencies weaken.

Jonathan Duensing, Head of the US Fixed Income Department at Amundi

Duensing leads a team managing around $50 billion in assets. Duensing stated: "Considering the discount level of the US Treasury yield curve front end, the extent of the dollar's weakness to date is understandable. But in our view, it seems a bit oversold in the short term."

Duensing said that if there is a risk of a US recession, the dollar may rebound as investors shift to quality assets. However, if the Fed's policy easing exceeds the level currently reflected in the market, the dollar may weaken For USD trading, Duensing pointed out: "If the Federal Reserve achieves a soft landing on inflation and manages to keep the US economy at a level that appears close to potential growth, you may see the dollar appreciate or depreciate by 3% to 5% over the next year."

Leah Traub, Portfolio Manager and Head of Foreign Exchange Team at Lord Abbett

Managing approximately $12.7 billion in funds, Traub stated: "When considering the year-end outlook for the US dollar, the most important factors for me are the Fed starting to cut rates, followed by global economic growth prospects, and finally the US presidential election."

Traub noted that as the Fed lowers interest rates, the leading edge of US Treasury yields may narrow. She said that if the Fed cuts rates by 25 basis points in September, they may also cut by 25 basis points in November, which could put pressure on the dollar. However, this scenario is already priced in.

She stated: "To keep the dollar weak, we need to see accelerated global economic growth, even as US growth slows. Looking around the world, I'm not sure where I see that happening."

Regarding USD trading, the company is not heavily betting on foreign exchange but is reflecting views on the dollar against non-US currencies through bond allocations. She said: "As signs of a slowdown in the US economy emerge and the Fed becomes more dovish, we have shifted more long-term exposure back to the US while maintaining an overweight position in non-US credit."

She mentioned that hedging costs for USD-based investors remain favorable. For example, buying bonds denominated in euros and hedging them back to dollars through a three-month forward contract would increase the annualized yield spread by 1.6%