Experts agree: The US Dollar rally might have found serious headwinds
- The US Dollar Index clings to gains above 100.00 on Friday after a 1.5% selloff following the Fed's monetary policy meeting earlier this week.
- Analysts observe that the lack of forward guidance by the central bank is likely to hurt confidence in the US Dollar.
- Experts at DBS Bank assess that the diverging communication styles of the ECB and the Fed will keep USD under sustained downward pressure.
The US Dollar Index (DXY) attempts to cling above the 100.00 psychological level on Friday after a nearly 1.5% selloff in the previous three days, as the Federal Reserve's (Fed) lack of forward guidance at Wednesday's monetary policy meeting raised concerns that the bank might fail on its commitment to fight inflation. Experts from some of the world's major commercial banks agree that this stance might trigger a long squeeze of global USD positions in the coming weeks.
Analysts at ING report that the post-FOMC Dollar selloff accelerated amid market concerns that the Fed “may be reluctant to translate its price stability rhetoric into effective policy tightening.” They observe that Fed Chair Kevin Warsh’s ambiguity is weighing on USD, whose recent “summer strength had been largely driven by Fed hike expectations.”
In ING’s view, “there may still be room for further USD long-squeezing,” as they remain reluctant to call the bottom in this dollar selloff just yet. The bank warns that “any disappointment in US data should lead to a larger dovish repricing than before, particularly if oil prices come under renewed pressure,” adding that upcoming “Fedspeak will also be crucial” in shaping the next leg for the Dollar.
Commerzbank experts warn about a dovish pivot and rate cuts in 2027
Analysts at Commerzbank argue that the US Dollar strength is unlikely to prove durable, warning that “the dollar is likely to be under pressure again after the end of the war with Iran because the Fed is unlikely to raise rates as markets have priced in.” Instead, they expect a decisive policy pivot, stating that “the Fed is likely to embark on pronounced and ultimately excessive interest rate cuts again in 2027, also because of the political pressure.” In their view, this prospective shift in Fed policy compounds an already fragile valuation backdrop, as “the dollar is vulnerable because it is significantly overvalued based on purchasing power parity.”
Strategists at DBS Bank remark that “our caution paid off,” as the USD “sank after the FOMC meeting did not turn out hawkish enough to deliver a Fed hike yesterday or to affirm one in September.”
In their view, the softer tone from the Fed, combined with what they describe as a “stark divergence in central bank communication,” now “threatens to keep the greenback under sustained downward pressure.” DBS contrasts the Fed’s approach with that of the European Central Bank, noting that “while Warsh leaves US markets stumbling in the dark, the European Central Bank was more unified in flagging a September rate hike, handing the EUR a distinct comparative advantage.”
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
