Dollar Risk: Fed Confirms Rate Cuts, Medium-Term Downtrend Resumes
Last week, Federal Reserve Chair Jerome Powell delivered a highly anticipated speech at the Jackson Hole Symposium, reassuring market participants that the time for easing monetary policy has arrived. This declaration provided a significant boost to US stock markets, with major indexes closing the week on a positive note. However, the real standout of the week was the Dollar, which tumbled across the board, emerging as the worst-performing currency.
The Dollar’s decline was largely fueled by a surge in risk-on sentiment rather than a significant change in expectations for Fed rate cuts. Market pricing for future cuts remained largely unchanged compared to the previous week. While the conditions are now ripe for further depreciation of the greenback, much will hinge on the evolution of risk sentiment, particularly as major stock indexes approach their record highs.
In the broader currency markets, the Canadian Dollar ended as the second-worst performer, weighed down by inflation data that solidified expectations for another rate cut from the Bank of Canada in the near future. The Euro also struggled, becoming the third weakest currency, as weak Eurozone PMI data highlighted underlying fragilities in the region’s economy.
On the flip side, the New Zealand Dollar stood out as the strongest currency of the week, rebounding from its recent losses. The Japanese Yen followed as the second strongest, supported by the determined hawkish tone from the Bank of Japan. The Swiss Franc also showed notable strength, while the British Pound and Australian Dollar ended the week in middle positions.
Dollar’s Slide: Is Medium-Term Downtrend Back on as Fed Confirms Cuts are Coming?
Investors seemed satisfied with the Federal Reserve’s communications last week, including insights from the July FOMC minutes and Chair Jerome Powell’s speech. While the messages delivered were largely in line with market expectations, the reassurance that monetary easing is on the horizon was enough to keep investors content.
The FOMC minutes revealed that a “vast majority” of participants viewed a rate cut at the upcoming meeting as likely appropriate, provided economic data continues to align with expectations. Powell echoed this sentiment, declaring that “the time has come for policy to adjust.” However, he refrained from specifying the exact timing or pace of future rate cuts, leaving the markets to speculate.
Market pricing for the September meeting indicates a 25 basis points cut is fully priced in, with a 24% chance of a more aggressive 50 basis points reduction. Looking ahead, by the end of the year, markets are fully pricing in a total of 75 basis points in rate cuts, with a 65% probability that the total reduction could reach or exceed 100 basis points.
This outlook has put significant downward pressure on the Dollar, which has tumbled broadly against its peers. The prospect of the Fed matching or even surpassing other major central banks in terms of monetary easing this year is exacerbating the downward pressure on the greenback.
The European Central Bank, for instance, is expected to cut rates again in September and possibly once more in December, totaling 75 basis points in cuts, including the June adjustment. These meetings will also feature updated economic forecasts from the ECB. Meanwhile, the Bank of England remains a wildcard, with uncertainty surrounding whether it will cut rates in September. A more likely scenario is a single cut in November when new forecasts are released. Including the August reduction, the Bank of England could cut just 50 basis points this year.
The Dollar index’s fall from 106.13 continued last week, with a strong break of medium-term trendline support, signaling that the downtrend from 114.77 might be ready to resume. The near-term outlook will remain bearish as long as the 103.67 resistance holds. A firm break of the 100.61 support will solidify this bearish case, with further break of 99.57 targeting 61.8% projection of 114.77 to 99.57 from 106.13 at 96.73, or even further to long-term channel support at around 94.61 before forming a bottom.
The bearish sentiment surrounding the Dollar is also supported by the outlook for the 10-year US Treasury yield. The fall from 4.737 is seen as the third leg of the corrective pattern from 4.997. Further decline is expected as long as the 4.022 resistance holds, targeting 100% projection of 4.997 to 3.785 from 4.737 at 3.525. Considering that the 10-year yield is now correcting the whole uptrend from 0.398 in 2020, there is a risk of even deeper decline to 3.253 cluster support before completing the correction.
However, risk sentiment remains a critical wildcard that could shift these developments. While major stock indexes ended higher last week, they remain capped below the record highs set in July. There is skepticism about whether the current momentum can extend or even surpass these records. Powell’s emphasis on supporting the labor market, particularly in the event of significant deterioration, suggests that upcoming job data could have complex impacts on market sentiment.
Strong job data could reduce the urgency for aggressive rate cuts, while weaker data might reignite recession fears but also push the Fed toward faster easing. This creates a complex dynamic where good news could be seen as bad news, and vice versa, depending on how markets interpret the data.
Yen Resilient with BoJ’s Commitment to Easing Adjustments
The Japanese Yen ended as one of the top performers last week, as its recent pullback lost steam. The currency found support from Bank of Japan Governor Kazuo Ueda, who reaffirmed the commitment to reduce monetary easing if economic and price trends align with their forecasts. Despite recent market volatility, Ueda made it clear that there is “no change to our basic stance to adjust the degree of monetary easing.”
Supporting Ueda’s position, IMF Chief Economist Pierre-Olivier Gourinchas emphasized that Japan’s inflation is now above 2%, aligning with or even slightly exceeding the Bank of Japan’s target. Gourinchas noted that Japan’s gradual shift away from its ultra-loose monetary policy is a positive development for the country, suggesting there is scope for further normalization of monetary policy with potential for gradual increases in policy rates going forward.
While New Zealand was the best performer last week, just outperforming the Yen slightly, further rise is in favor for NZD/JPY as long as 87.99 minor support holds, towards the 55-day EMA. However, considering bearish divergence condition in 4H MACD, a break of 87.99 will argue that the rebound from 83.02 is over, bringing a retest of this low.
CHF/JPY has failed to break through resistance, and a break of support will argue that the fall from the high is ready to resume. EUR/GBP accelerates down as PMIs highlight contrasting economic strength. Sterling outshined the Euro last week, supported by stronger PMI data that highlighted solid expansion across both the UK manufacturing and services sectors in August. The UK economy demonstrated a combination of stronger growth and improved job creation.
In contrast, the Eurozone’s economic picture is showing signs of strain as seen in their PMIs. While French services received a temporary boost, the broader Eurozone fundamentals remain shaky, with Germany’s economic troubles at the forefront. The increased likelihood of Germany experiencing negative growth raises the specter of a renewed recession in Europe’s largest economy.
EUR/GBP’s downside acceleration suggests that the rebound has completed, keeping the medium-term downtrend intact. The break below both the 55-day and 55-week EMA are bearish signals, with a retest of the low expected. The question now is whether EUR/GBP would accelerate downward through to resume the larger downtrend.
EUR/USD Weekly Outlook
EUR/USD’s rally continued last week, with a strong break of resistance indicating that the larger uptrend may be resuming. The initial bias is on the upside for the week, targeting the 161.8% projection. On the downside, below minor support will turn intraday bias neutral and bring consolidations first.
In the bigger picture, the break of resistance indicates that the corrective pattern has completed. A decisive break of the high will confirm the whole uptrend, with the next target at the 61.8% projection.
In the long term, a bottom is in place, with the break of the moving average taken as the first sign of bullish trend reversal. However, a firm break of structural resistance is needed to confirm this trend.
In conclusion, the Dollar’s decline, Fed’s commitment to rate cuts, and global economic dynamics all point to a complex and uncertain future for the currency markets. As investors navigate these challenges, staying informed and adaptable will be key to capitalizing on opportunities and managing risks effectively in the weeks and months ahead.
