2023-04-24 06:59:00
US dollar (expressive)
America’s economy
History shows that the Fed can cut more than other central banks
Professional investors see the dollar slipping further from the two-decade highs of last year as the market undervalued the Fed’s upcoming easing cycle.
About 87% of 331 respondents to the weekly Bloomberg Readers’ Survey, known as MLIV Pulse, expect the Fed to cut interest rates to 3% or less, in an easing cycle that 40% think will start this year.
This contrasts with market rates that put the implied policy rate around 3.05% in two years’ time.
In contrast, professional investors had a negative view of the dollar, with a 17 percentage point gap between the bears and the bulls.
Many openly state that their expectations are bearish because the US interest rate is so high. Interestingly, the second most common response is that banking sector pressures will be largely confined to the United States, which also means that the Federal Reserve will have to be more pessimistic than its global counterparts, according to what was seen by Al Arabiya.net.
As strange as it may sound at first, there is already historical precedent for the Fed cutting sharply without other central banks following suit.
During the tech crash of the early 2000s and the year before Lehman Brothers collapsed, US monetary policy diverged radically from its global counterparts. In the latter case, the Fed cut 325 basis points between August 2007 and April 2008, while the European Central Bank raised the rate by 25 basis points in July 2008 – the dollar was very weak in the run-up to the global financial crisis.
But pessimism about the dollar is not just a product of US problems. As a large group of investors believes that the appreciation of the Japanese yen or the Chinese yuan will be the main reason for the decline of the dollar.
Why the surprise?
First, New Bank of Japan Governor Kazuo Ueda has done his best so far to be as sluggish as possible, offering a little hope to those betting on an end to the ultra-easing monetary policy that has weakened the yen. However, Ueda has a convenient window to remove yield curve control while there is little pressure on the domestic price markets. And if he chooses to act, it could potentially lead to a significant appreciation of the yen – there is evidence that even small changes in BoJ policy can have a huge impact on the currency.
Secondly, Citigroup’s China Economic Surprise Index rose near the highest level since 2006 this month, yet the yuan is up only 1% against a weighted basket of currencies so far in 2023. Although the natural reaction to this is the yuan strengthens. Worryingly, however, the currency has been almost insensitive to the good news, as it is hard to imagine what more the nation could do to impress them. Aside from the ongoing geopolitical risks, it may simply be that investors need time to get used to the idea of a return to Chinese trade.
Reverse dollarization?
Investors consider the risk of a mass move away from the US currency to be watched seriously. The majority of respondents believe that the dollar will account for less than half of global reserves within a decade.
On the other hand, there are still dollar bulls, especially among retail investors. The vast majority of US currency lovers believe that the Fed’s interest rate path is undervalued, which confirms that correcting the currency’s direction will eventually lead to the realization of the monetary policy decision.
Interestingly, the risk of a debt-ceiling catastrophe goes almost unmentioned. However, few would argue that today’s political environment is very dangerous and the stakes are as high as they were many years ago. What happened in 2011 is the best model for judging the market’s likely response to a serious incident. At that time, yields fell dramatically, however the dollar rose during this period as risk aversion dominated investors’ thoughts.
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