US dollar to weaken, but Fed rate cuts are required, say strategists

BENGALURU – The dollar’s relentless strength in the recent past will make way for minor weakness over the next 12 months, according to FX strategists in a Reuters poll, who generally agreed the dollar was overvalued.

Analysts have been predicting dollar weakness just around the corner for months. But the greenback has continued to extend its dominance against most major currencies, with the dollar index up 2.9% this year.

Much of that resilience is down to interest rates staying higher for longer. At the beginning of the year, forecasters and financial markets had predicted the US Federal Reserve would have cut rates at least once by now.

With the latest interest rates futures pricing showing the Fed would start easing policy in September, analysts in the May 31-June 4 poll of 75 forex strategists forecast the dollar to give up some its gains in coming months.

Much hinges on how US inflation – at 2.7% as measured by the Fed’s preferred gauge – progresses over the next couple of months.

A separate Reuters poll showed inflation averaging above the Fed’s 2.0% target at least until late 2025, suggesting the risk was the dollar would remain strong for an extended period.

“We think US inflation could be picking up again by the middle of the year and the Fed easing cycle could be really very short, almost irrespective of when it does commence,” said Jane Foley, head of FX strategy at Rabobank.

“That means even though the dollar will give back some ground, when the Fed starts to cut, the dollar is likely to remain relatively firm. It’s not going to give back an awful lot of this year’s gains and it’s going to remain overvalued.”

While nearly all major currencies have faced the wrath of a strong dollar, the Japanese yen JPY= was the only currency to weaken against the greenback every year since 2021. The currency has shed over a third during that period.

Median forecasts showed the yen rising nearly 8% from current levels to trade around 145.00/dollar in 12 months. The currency has lost around 10% for the year.

Meanwhile, the euro was forecast to change hands at USD 1.08 and USD 1.10 in six and 12 months, suggesting a gain of around 1% in a year from now.

“We’re expecting the dollar to generally lose ground against other currencies…once the Fed starts to cut, the dollar should be vulnerable and should give up some of its strength,” said Brian Rose, senior economist at UBS Global Wealth Management.

“We’re not looking for any kind of dollar collapse. We’re just talking about giving up a few percent against most major currencies.”

(Analysis by Purujit Arun; Polling by Rahul Trivedi, Susobhan Sarkar, and Sarupya Ganguly; Editing by Ross Finley and Alexandra Hudson)