Is the Dollar Too Strong? Analysts Warn of Potential Risks

According to foreign exchange experts, the dollar is anticipated to remain strong in the upcoming months as markets reevaluate how quickly the Federal Reserve may lower interest rates.

Contrary to a temporary decline that began in late 2018, the dollar index increased by around 2.0% in only the month of January. Rate futures indicate that a number of Fed officials have reined in the wild market speculation that rates would be reduced in March. This has happened from a peak of almost 90% to a chance of less than 20%.

The majority of residual prospects of early rate reduction have been dashed by a disastrous January employment report, blatant clues from the US central bank following the conclusion of a policy meeting last week, and a follow-up TV interview with Fed Chair Jerome Powell.

For the third week in a row, currency speculators have already reduced their short dollar bets, according to the most recent statistics from the Commodities Futures Trading Commission. This trend is probably going to continue.

According to a Reuters poll conducted from February 1 to 6, nearly 80% of foreign exchange (FX) strategists, comprising 52 out of 67 respondents, stated that the primary risk to their six-month forecast was for the dollar to trade stronger than initially predicted. The remaining 15 strategists expressed the view that the greater risk lay in the dollar being weaker than anticipated.

Paul Mackel, HSBC's global head of FX, noted that the market initially questioned whether the dollar would continue weakening at the start of the year but has since shifted towards the belief that a strong dollar may be more likely, emphasizing that the pace at which central banks cut rates will play a crucial role in determining currency performance.

Analysts Forecast Lagging Development of Major Economies

Most analysts predict that the development of the big economies will lag behind the United States, and that rate differentials will work in favor of the greenback. As a result, it will be difficult to unseat the dollar in the near run.

The dollar would, however, drop from its present levels versus the majority of global currencies in the following three, six, and twelve months, according to the median projection of 76 strategists questioned. This is an assessment that experts have held for about a year.

George Saravelos, head of FX research at Deutsche Bank, questioned the logic behind the market pricing similar cumulative rate cuts from the Federal Reserve, European Central Bank (ECB), and various other central banks, stating, "we don't think so." He emphasized that the real debate revolves around the extent of rate cuts by the Fed compared to other central banks over the next two years, rather than the timing of these cuts. Saravelos suggested that the risks lean towards less easing by the Fed, hence favoring the USD.

On Tuesday, the euro, trading at approximately $1.07, was anticipated to appreciate by more than 4.0%, reaching $1.12 within 12 months. Forecasts also indicated that the Japanese yen could strengthen by over 9.0% from its current levels to 135.50 per dollar. Median views for most major currencies remained largely unchanged since December.