Will the Strong Dollar Trend Persist?
The U.S. dollar index, after a brief moment of adjustment last week, has started to regain strength as this week unfolds. Observations from the forex market on Monday indicated a divergence taking shape, with the euro experiencing a notable decline, falling back below the 1.05 mark, while the Japanese yen maintained a relatively strong position, stabilizing under the 150 level against the dollar. The offshore yuan, having navigated a period of stability, also saw a significant drop, even dipping below 7.30 for a time. Meanwhile, yields on U.S. Treasury bonds remained relatively stable, suggesting a substantial divergence between the dollar index and the yield on 10-year Treasuries, which has drawn attention.
Clearly, the market still harbors confidence in a strong dollar, indicating that the prior abrupt adjustment in the dollar was largely a consequence of marginal position reshuffle. Additionally, adverse impacts from tariff policies on Europe and China could be felt, while the outlook for Japan's economy appeared more optimistic, coupled with speculation that the Bank of Japan might raise interest rates later this month. In light of this strong dollar backdrop, the emerging currency pairs exhibited a certain level of differentiation, which seems only natural.
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Should the dollar continue its robust performance this month, it would disrupt the traditionally weaker seasonal performance seen in the dollar during the fourth quarter. Notably, throughout the second half of this year, the dollar has shown 'counter-seasonal' characteristics. With expectations of interest rate cuts exerting influence, the dollar index faced declines during July, August, and September, starkly contrasting with seasonal trends observed over the previous five years. Yet, entering the fourth quarter of this year, the dollar index rebounded powerfully, breaking the long-standing trend of weakness typically seen in the dollar as winter approaches.
The trajectory of the expected interest rate cuts by the Federal Reserve has undoubtedly served as a backdrop for the dollar’s rise. Next week’s FOMC meeting is said to likely yield a 25-basis-point cut; however, the market is rife with speculation over the rate-cutting path for 2025. Consequently, the Fed may need to tweak its forecasts concerning inflation as well as the dot-plot, in response to shifts within the economic landscape. Under these circumstances, the market finds itself aligned with expectations of 're-inflation' and a strong dollar.
Additionally, the recent moderate performance of U.S. Treasury yields suggests that market sentiment sees 'strong dollar' as a more suitable expression of 're-inflation'. In principle, 're-inflation' signals that Treasury rates are more prone to rise rather than fall, yet comments from policymaker Bessenet on controlling fiscal deficits, along with current market pricing anticipations of a potential 50-basis-point cut from the ECB this month, coupled with the 10-year Chinese government bonds yielding below 2%, all indicate a lack of upward momentum for U.S. Treasury yields. In this context, the combination of a 'strong dollar' with 'moderate rates' has positioned U.S. Treasuries as a favored choice in the realm of global macro trading.
Navigating the intricate chessboard of global financial markets, the forthcoming Federal Reserve meeting is poised to be a highly influential piece. If the Fed adopts a hawkish tone at the meeting next week, it could well set a trajectory for the dollar to maintain its strength leading up to the year-end. This change could hold substantial significance, as it would signal a departure from the established pattern of dollar weakness seen in the final months of recent years. Observing historical trends, the strong performance of the dollar at the start of the year can be noted. However, considering that the dollar may return to such seasonal strengths at the beginning of 2025, the prospects for non-dollar currencies appear fraught with challenges ahead, potentially enduring pressures leading to lower exchange rates and heightened risks of capital outflows. This looming scenario would influence various economic activities such as foreign trade and cross-border investment across nations, thereby triggering profound and subtle shifts in the global financial market landscape. Investors will need to reassess their asset allocation strategies thoroughly, in preparation for potential market fluctuations and risks.
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