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Dollar to remain elevated in spite of rate cuts

Published 08/24/2024, 05:30 AM
Updated 08/24/2024, 01:45 PM
© Reuters Dollar to remain elevated in spite of rate cuts
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Despite the expectation of significant rate cuts by the Federal Reserve in 2024 and 2025, analysts at Wells Fargo Investment Institute predict that the U.S. dollar will remain elevated.

Analysts in a note dated Monday mention reasons behind this forecast, focusing on interest rate differentials, global economic conditions, and the performance of the U.S. dollar relative to other major currencies.

Interest rate differentials have been a major factor in driving the U.S. dollar's strength over the past few years. Since the Federal Reserve began its aggressive rate hike campaign in March 2022, the U.S. dollar has consistently traded above its historical averages.

With the Fed poised to begin cutting rates, it might seem logical to expect a significant depreciation of the dollar.

However, analysts argue that the dollar is likely to remain within its recent trading range, largely because other major central banks, including the European Central Bank, are also expected to reduce their rates.

The interest rate differential between the U.S. and other developed economies is expected to persist, albeit at a reduced margin, which should continue to support the dollar. The European Central Bank, for example, is projected to keep its rates relatively flat, while the Bank of Japan is expected to implement rate hikes, though these will still leave a notable differential in favor of the dollar.

The global economic landscape plays a crucial role in the dollar's outlook. The eurozone, in particular, faces significant economic challenges, including sluggish demand for exports driven by ongoing weakness in the Chinese economy. This could further weigh on the euro, thereby providing additional support to the U.S. dollar.

Furthermore, while the U.S. economy is expected to slow down, it is still anticipated to outperform many of its global peers. This relative economic strength, combined with the Fed’s cautious approach to rate cuts, is likely to prevent a sharp decline in the dollar’s value.

The U.S. dollar index, which measures the dollar against a basket of six major currencies, has remained above its historical averages since the onset of rate hikes. “Our outlook is now for less strength in the dollar and to remain close to — if not slightly above — its recent range of values,” the analysts said.

As per Wells Fargo, even with upcoming rate reductions, the dollar is not expected to retreat significantly from its current levels. The dollar index’s resilience reflects both the interest rate differentials and the broader global economic uncertainties that are likely to keep demand for the dollar strong as a safe-haven currency.

Analysts continue to express a preference for U.S. equities and fixed income over international or emerging market assets, partly due to the expected strength of the dollar. The sustained strength of the dollar could impact global markets, making U.S. investments relatively more attractive.

For investors, this outlook suggests that the dollar's position as a global leader will remain intact, even as the Fed shifts its monetary policy stance. This is expected to provide continued support for U.S. assets, reinforcing the strategic allocation towards domestic markets.

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