Does the dollar have more scope to weaken from here?

Author: Justin Low | Category: News

The big question in markets right now is how aggressive will the Fed be in pursuing easing monetary policy after the 25 bps rate cut this month?

Dollar bruised
Ultimately, what all this will boil down to is a question of yields. There's no doubting that the US still pays the best in terms of yields right now - when viewed from a comparative standpoint. However, for traders/investors, it's all about what will happen moving forward.

If the Fed is going to be more aggressive in easing, that will more likely than not see US yields fall much faster than its peers given how much room the Fed has to cut rates. If you compare that to the likes of Europe, Japan or even the UK, their respective central banks won't have as much ammunition to lower rates and compress yields further.

Another point to consider is that structurally, the dollar is also one of the more "overvalued" currencies when measured from a PPP perspective. I don't often use this as a gauge but to some extent it reveals positioning by traders/investors over a period of time.

WCRS PPP
Given how "overvalued" the greenback is, should the Fed actually look to ease more and send US yields much lower from here, there is incentive for traders/investors to not only switch to other bond markets but also opt for those which currencies are "undervalued" i.e. potentially the euro, yen, and pound.

All this talk of course is mere conjecture for now and the situation is always evolving but it is something to consider in the bigger picture down the road.

On the flip side, if the Fed is only after an "insurance rate cut" to save ammunition in case of a worse downturn in the economy (there's a solid case to do that as well), that will keep US yields underpinned over the next few months.

In turn, that will also buoy the dollar amid other central banks looking to ease further and you can throw away the stuff about "overvalued" and "undervalued".

There's an argument for both sides of the story and that's the key debate that markets are trying to work out right now. We'll have just over two weeks to learn more about the Fed's plans for the big picture but knowing the central bank, they'll always try to keep markets guessing if and when they can.

What do you think of the dollar right now? Is this the start of a cyclical decline for the currency or just a bit of a pause? Don't forget the Trump factor too.
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