The US dollar is expected to face increasing downward pressure in the coming months, despite recent support from stronger-than-expected economic data.
According to analysts at UBS, the outlook for the US dollar remains bearish, driven by a combination of narrowing interest rate differentials, concerns about the widening US fiscal deficit, and a shift in global monetary policy.
In light of these factors, UBS has downgraded the US dollar to “least favoured” in its global strategy, favouring currencies such as the euro, sterling and Australian dollar instead.
The US dollar made some gains on Thursday after the release of revised second-quarter GDP growth figures.
Meanwhile, second-quarter GDP was revised up to an annualized growth rate of 3.0% from the previously reported 2.8%, driven mainly by increased consumer spending.”
This revision was largely driven by increased consumer spending, which also saw an upward revision to an annual rate of 2.9% from 2.3% initially.
This positive data helped the US dollar recover slightly, but it is still under pressure. It has fallen 3% over the past month and continues to hover near the lower end of its range since early 2023.
Despite this temporary improvement, UBS analysts see the broader outlook for the dollar as negative, with several factors likely to push it lower in the coming months.
One of the main factors expected to affect the US dollar is the narrowing of interest rate differentials.
The US Federal Reserve is likely to continue cutting interest rates, with UBS forecasting a total cut of 100 basis points in the remaining three Fed meetings in 2024.
While other central banks, including the Swiss National Bank, the Bank of England and the European Central Bank, are also expected to cut rates, their approach is likely to be more conservative.
This slowdown in the pace of devaluations abroad could make the dollar less attractive compared to other currencies.
In addition to interest rate expectations, concerns about the U.S. fiscal deficit are expected to erode confidence in the dollar. The Congressional Budget Office has projected that interest costs on U.S. debt will exceed defense spending this year, highlighting the country’s growing fiscal challenges.
As the US presidential race heats up, with Vice President Kamala Harris currently leading in the polls, the fiscal deficit is likely to become a focal point of debate, potentially creating additional headwinds for the dollar.
Shifts in global monetary policy also pose a challenge to the US dollar. For example, the Reserve Bank of Australia is expected to maintain its current policy stance until next year, which could add pressure on the dollar.
In contrast, the Swiss franc is expected to remain strong due to its safe-haven status and the expected end of the Swiss National Bank’s monetary easing cycle in September.
UBS expects the euro, pound and Australian dollar to strengthen against the US dollar by June 2025, at 1.16, 1.38 and 0.70.
The expected weakness of the US dollar has significant implications for global markets. As the dollar declines, riskier assets such as good stocks are likely to become more attractive, especially in an environment where the Federal Reserve is cutting interest rates.
UBS suggests that investors consider reallocating cash into higher-quality bonds, particularly those issued by investment-grade companies, to take advantage of the changing economic landscape.
Despite some signs of weakness in the U.S. labor market, such as a rise in the unemployment rate in July, the overall picture remains resilient. Weekly jobless claims have fallen and consumer spending continues to show strength, easing fears of an immediate recession.
UBS maintained its core forecast of a soft landing for the US economy, supported by expected interest rate cuts by the Federal Reserve.