The recent bull run in the greenback will go on for longer as hopes of a Fed pivot may be overdone, Capital Economics has said.
“Although the US dollar has faltered over the past couple of weeks, we doubt its bull run is over,” Jonas Goltermann, Senior Markets Economist at the house said in a note.
After reaching a 20-year high in mid-July, the dollar index has eased sharply and is trading lower by around 2.5 percent from its peak. While currencies like the Japanese yen have appreciated by more than 5 percent against the dollar, the rupee has gained over 1 percent to an over five-week high on August 2.
Finance Minister Nirmala Sitharaman said in parliament on Tuesday that the rupee is not collapsing and will find its natural course. Concerns over India’s current account deficit and inflation has worsened in recent weeks as the rupee plumbed to fresh lows against the dollar. The country imports 85 percent of its crude oil needs.
According to Capital Economics, two key factors explain the dollar’s recent setback.
The narrowing yield differentials since last week’s Federal Reserve meeting and easing safe-haven demand for the greenback, which appears to have driven much of the dollar’s surge since early June.
Still, with inflation far above target, the Fed is unlikely to welcome the easing of financial conditions and fall in real yields and could push back.
Moreover, “it is far from obvious that the dollar will fall on a sustained basis even when the Fed does end its hiking cycle,” Goltermann said.
He adds that in 2019, the dollar stayed strong despite the Fed cutting rates amid safe-haven demand on account of the US-China trade war and a global slowdown.
The dollar also rose in 2000-02 even as the Fed cut rates but the stock market plunged and the global economy fell into recession.
“We think a similar pattern will play out this time around: we expect a continued worsening of the economic outlook and faltering risk appetite to support the dollar for some time yet,” the economist said.