Outlook for USD appears to be torn between opposing forces

A weakening of the US dollar may be on the horizon owing to a struggle between a slowing American economy and the increased prospects for a US Federal reserve interest rate, according to a leading market strategist. 

In a note to clients, ahead of the Fed meeting on 17 June 2019, Richard Falkenhäll, senior FX strategist at Nordic bank SEB, said that although the Fed has so far only communicated a pause in rates, it has stated that it is prepared to support the economy if necessary, and it seems increasingly likely that it could be moving towards lowering rates this year after four rate hikes in 2018.

“The money market is prepared for rate cuts and is discounting almost three 25bps cuts before year-end and more than one cut until the September 2019 meeting. So far we have had the view that the Fed will keep rates unchanged this year, but the likelihood of a rate cut later this year has increased significantly in recent weeks,” Falkenhäll noted.

There are few signs that the global economy will improve, while the risks that the trade talks between the US and China will escalate into a full blown trade conflict with repercussions for the global economy have increased further.

“With an increased probability for rate cuts by the Fed, we have revised our forecasts for the USD in Q3 and Q4 2019 and have moved forward the timing of the USD weakness we previously expected towards the end of this year,” Falkenhäll added. 

Current market expectations on the Fed are aggressive and there is a risk of a disappointment on the 17 June meeting that could give a brief support to the USD. “However, after the Fed decision we expect the USD to weaken in a struggle between a slowing economy and the prospects for a Fed rate cut. If the Fed eventually announces a rate cut, it will then weaken the USD further,” SEB strategist noted.

Consequently, SEB has lifted its EUR/USD forecast for Q3 2019 to 1.15 and the Q4 2019 forecast to 1.17. “The negative impact on the USD from Fed rate cuts will probably not be long-lasting, and it might be the case that the defensive qualities of the USD eventually will dominate and determine its direction in 2020. Therefore, the 2020 forecast is more difficult as it will depend on the how the US economy and the global economy develops and what happens to global risk appetite next year,” Falkenhäll concluded.