The US dollar fell this week as stock markets recovered from early August declines, while expectations of a more dovish Federal Reserve policy continued.
UBS Global Research analysts warn against assuming the US dollar will continue to fall. Although the euro has reached a new high against the US dollar in 2024, the rise may be overdone given the economic fundamentals.
Technology stocks rose sharply, driven by improved risk sentiment and a partial recovery in equity markets, with August losses being clawed back and volatility indicators such as gold falling.
Despite the rise, U.S. Treasury yields have risen only modestly, and market pricing suggests the Federal Reserve could cut interest rates by about 100 basis points this year, including a potential 50 basis point cut in September.
This market situation suggests that further significant dollar weakness could face significant hurdles, especially since expectations regarding Fed policy have already largely been priced in.
“The recent price action raises the question of whether the market is finally shifting to a broadly bearish view of the US dollar and whether the dollar is poised for further significant weakness,” analysts at UBS Global Research said.
Although the Fed appears ready to ease monetary policy, possibly with a 25bp cut in September, the market’s aggressive outlook may leave little room for dovish surprises. Any positive US economic data, such as a rebound in nonfarm payrolls, could lead to a tactical recovery in yields and the US dollar.
Analysts also point out that the broader global economic outlook remains uncertain, with limited signs of improvement outside the U.S. China’s stimulus efforts have yet to convince markets, and the euro zone continues to face downward revisions to growth forecasts. These factors reduce the likelihood of a major shift away from the dollar and U.S. assets.
UBS analysts see the recent EURUSD rally, which has broken past previous highs, as an overshoot of short-term fundamentals. The brokerage model estimates the EURUSD fair value at a level closer to 1.0950, which is lower than current levels.
The divergence suggests that the pair is pricing in either unexpected weakness in the US or over-optimism about the European economic outlook. However, UBS remains skeptical about the eurozone growth outlook, pointing to negative economic surprises and persistent headwinds in major economies such as Germany.
Given these considerations, analysts believe that the EUR/USD pair may struggle to sustain levels above 1.11 for a long time, especially if upcoming Eurozone data fails to meet expectations.
UBS analysts also discuss other major currencies, noting that recent moves in the Japanese yen and Swiss franc reflect more global risk sentiment than fundamental shifts.
Morgan Stanley expects the Bank of Japan to continue its cautious approach, which could lead to a rebound, providing a better entry point for short positions. At the same time, the bank sees limited declines in the Swiss franc and expects it to remain rangebound near current levels.
In Scandinavia, UBS analysts favor the Norwegian krone over the Swedish krone, citing a more positive outlook from Norway’s central bank. They recommend maintaining a short position in the Norwegian krone, expecting the recent recovery in the Norwegian krone to be more sustainable than that in the Swedish krone.
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