The U.S. Federal Reserve’s decision to pause its rate hike campaign last week may hamper the dollar’s rally, said analysts.
The DXY, an index that tracks the U.S. dollar’s performance against six major currencies, has fallen from its two-decade high hit in September 2022. However, data show that the index still trades around multi-year highs.
Morgan Stanley Wealth Management chief investment officer Lisa Shalett said the Fed’s consecutive rate hikes had attracted flows, helping to “keep the dollar strong.” Meanwhile, the Fed’s decision to keep the federal fund rate steady at 5.00 to 5.25 percent last week and the expectations that it will soon end its tightening cycle will lead to further decline of the dollar in the forex market.
The market now predicts that the U.S. central bank will hike its benchmark rate by 25 basis points next month. The central bank is also expected to start cutting rates next year.
Goldman Sachs forecasts a “bumpy downside” for the greenback in the second half of 2023 and into the following year. Deutsche Bank also published a note to warn investors of “medium-term weakness” in the U.S. dollar. According to Deutsche Bank strategists, the Fed’s policy pivot will prompt a sell-off of the greenback in financial markets.
“Given the fact that the Fed has raised interest rates in the US at the fastest pace in about 40 years… that’s attracted flows, which has helped keep the dollar strong.”
Lisa Shalett, Morgan Stanley Wealth Management chief investment officer
Other experts yet point out that the dollar’s decline is contained despite the Fed’s effort to slow the economy. Peterson Institute for International Economics senior fellow Joseph Gagnon said the dollar’s strength came from the resilient U.S. economy. Gagnon explained that European and Asian economies’ “relative weakness” against the U.S. increased the market’s appetite for the dollar.
“I don’t see anything on the horizon that would weaken the dollar,” said Gagnon.
Shalett said there would be challenges to the U.S. dollar’s “supremacy” in the longer term. She discussed the U.S.’s increasing debt levels and a potential declining appetite from foreign investors in the U.S. debts. Last month, U.S. lawmakers agreed to increase the national debt limit by $1.5 trillion until the New Year of 2025. The U.S. debt limit hit $32 trillion two weeks after the deal.
Analysts have warned that the effect of the debt ceiling crisis will persist for a longer period. The Treasury Department is issuing a large number of government bills to replenish its cash balance. Economists say this large-scale bill issuance will pull liquidity from the market, further reducing credit availability for American consumers and businesses.
According to Shalett, the “de-dollarization” trend also poses risks to the greenback’s dominance in the global economy. Several countries, including Russia and China, have begun to reduce their reliance on Western currencies over the past year. Although the U.S. dollar remains the most used currency in global trading, its share in global reserves has declined.
Downsides of strong dollar
Analysts explain that a strong dollar can hurt American employees and business entities. Gagnon said the dollar’s strength had increased the prices of U.S.-made goods, leading to reduced U.S. exports, forcing manufacturers to slash their production and human resources.
Gagnon also said the strength had weighed on U.S. tourism. The high rate of the dollar relative to other currencies deterred many tourists from visiting the U.S. This situation reduces demand for U.S. hotels, restaurants and attractions.
The dollar’s strength also creates pressure on other markets. Risk assets like cryptocurrencies decline when the U.S. dollar rally because they are denominated in the greenback. Bitcoin fell from its all-time high of around $69,000 — breached in November 2021 — last year as the U.S. dollar rallied on the Fed’s rate hikes.
Analysts also say the greenback’s strength reduces appetite for commodities, affecting economies that rely on the sector.