Investing.com — The U.S. dollar broke a four-week losing streak on Friday, and some believe it’s time to buy the greenback as the fighting spirit is expected to continue.
“We had been recommending a range trading for the dollar index between 101 and 108. The dollar index has recently entered the buy zone, and we suggest that now is the time for investors to hold long positions,” BCA Research said in a recent note.
The US Federal Reserve notes that the bullish outlook for the dollar has history, or the history of the rate-cutting cycle, in its favor, adding that the ebb and flow of the FX market during the rate-cutting cycle is fairly consistent.
The dollar has tended to flatten or fall in most cycles leading up to the first Fed rate cut. But the dollar is now at its lowest levels compared to previous cycles, assuming the Fed starts cutting rates in September, suggesting that the room for significant downside may be limited.
“The average rise in the US dollar index over the 12 months following the Fed’s policy easing was 5%,” BCA added.
In previous easing cycles, the Fed has cut rates by an average of about 400 basis points over the 12 months following the start of an easing cycle. But this time, the market is pricing in a Fed rate cut of about 200 basis points, or half the historical average.
“If our thesis is correct and the Fed does not cut interest rates by more than what is already priced into the markets, this bodes well for the dollar,” the Fed said.
The divergence in monetary policy expectations between the US and other major economies is also expected to support the dollar.
“Our work (on the sensitivity of GDP to interest rates) suggests that policy is already too restrictive for the UK and the euro area. These economies are likely to experience a relatively deeper recession than the US,” the central bank watchdog said.
But not everyone is convinced that the dollar’s recent strength represents the start of a long-term rally.
Sentiment towards the dollar is already bullish, BCA says, as “most investors already have long dollar positions,” raising the risk of a catalyst forcing a potential liquidation of leverage in long dollar positions.
“This catalyst will come in the form of higher equity prices, lower bond yields and lower volatility,” BCA said, pointing to volatility as a key indicator to watch given its close correlation to the dollar.
“One of the measures we’re most interested in is that we’ll be watching volatility trends,” she added.
Comments are closed, but trackbacks and pingbacks are open.