Expectations for the U.S. dollar's trajectory in the coming months suggest it will retain its strength as investors adjust their forecasts for Federal Reserve interest rate reductions. This outlook is supported by a consensus among currency experts, who anticipate the greenback's robust performance to continue, influenced by the financial market's reassessment of the Federal Reserve's interest rate strategies.
Despite experiencing a slight dip towards the end of 2023, the U.S. dollar has seen a 3.3% increase against a group of major currencies this year. This surge is underscored by trading data, which reveals that bets in favor of the dollar have reached their peak since September 2022.
The resilience of the U.S. economy coupled with persistent inflation has led to a reevaluation among market participants regarding the anticipated timing of the Federal Reserve's initial rate cut. Although there is currently a 60% likelihood of a rate reduction in June factored into market prices, expectations now include around 75 basis points in cuts for the entire year, aligning closely with what some Federal Reserve officials deem as "reasonable" and reflective of their projections.
However, this adjustment in expectations is significantly less than the nearly 150 basis points of reductions anticipated earlier in the year, indicating a continued dominance of the dollar in the short term. Currency strategists, from a recent poll, do not foresee any major currency recovering its year-to-date losses against the dollar in the next three months.
Analysts, including those from Goldman Sachs, suggest that the market is gradually recognizing the current environment as one not hastening towards rate cuts. This realization is expected to provide ongoing support for the dollar, at least until there is more clarity on inflation trends.
The euro, which is currently valued at around $1.08, is predicted to climb approximately 1.0% to $1.09 by the end of June, slightly narrowing its 2.3% deficit experienced so far this year. It is then projected to gain an additional 1.0% reaching $1.10 in the subsequent six months, based on median forecasts from 90 currency analysts.
Regarding the Japanese yen, which has depreciated nearly 25% since early 2022 and saw a 1% decline following the Bank of Japan's interest rate hike last month, it is forecasted to be one of the major currencies to significantly appreciate against the dollar within the next year.
Currently valued at 151.7 against the dollar, the yen is expected to ascend approximately 6.1% to 143 by the end of September, with further strengthening anticipated to 139 in 12 months, contingent on additional rate hikes by the Bank of Japan.
Should these projections materialize, it might prompt the Japanese authorities to intervene in the currency market, especially considering their recent statements regarding taking "decisive steps" to counteract yen weakness, reminiscent of their last intervention in October 2022.
When queried on the yen's status as the preferred currency for carry trades, a significant majority of experts, 26 out of 30, affirmed its position, with the Swiss franc being the alternative choice for the remaining respondents.
Bank of America's FX strategist, Alex Cohen, noted that the market had already adjusted to the Bank of Japan's policy shifts, resulting in a typical 'buy the rumor, sell the fact' reaction for the yen. He emphasized that carry trades continue to drive the yen's use as a funding currency, a trend unlikely to change with minor adjustments to policy rates.
