The dollar is expected to rebound as the Federal Reserve’s dovish stance runs dry, according to ING. The bank warns against chasing the dollar lower as Treasury yields could continue to climb, especially since there is limited room for further dovish re-pricing in the USD swap curve. Front-end US treasury yields, including the 2-year yield, are trading close to cycle highs, and equities are showing signs of instability. This places the dollar in a solid position to rebound from current levels.
Despite expectations for easing inflation pressures in the upcoming US data, ING believes that this is unlikely to force markets to price out a July interest rate hike. Traders are currently pricing in about 25 basis points of Federal Reserve tightening, which falls short of the 50 basis points projected by the central bank.
The US dollar index, which measures the greenback against a basket of six major currencies, fell by 0.33% to 101.61.
Cleveland Fed President Loretta Mester, a non-voting member, has emphasized the need for higher interest rates to bring inflation down to the central bank’s 2% target. She stated in a virtual speech at the University of California, San Diego forum that in order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving.
ING is not the only institution expecting a rebound in the US dollar. Montreal-based Desjardins also believes that a further rebound is likely. However, it notes that the eventual rate-cutting cycle expected next year to support the global economy would limit upside potential for the greenback.
A more favorable economic environment in 2024, with interest rates falling, would be more conducive to the US dollar depreciating against several currencies, Desjardins added.
In summary, ING advises against chasing the dollar lower as Treasury yields may continue to climb. Despite easing inflation pressures, a July interest rate hike is unlikely to be priced out by the market. Fed members, including Cleveland Fed President Loretta Mester, continue to call for higher interest rates to bring inflation back to the central bank’s target. Desjardins also expects a rebound in the US dollar, although it notes that the eventual rate-cutting cycle expected next year could limit upside potential.
