Strong dollar could be tested by Fed rate cuts

The dollar has remained at very high levels for the past four and a half years.

Strong dollar could be tested by Fed rate cuts

The dollar has remained at very high levels for the past four and a half years.

It has been aided by continuing strong US economic growth. Indeed, the current US expansion is now the longest on record. As a result, the country's jobless rate has fallen to a near 50-year low of 3.6%.

Widening interest rate differentials have also helped the currency, with the Federal Reserve steadily tightening policy in 2017-18, raising the fed funds rates by 200 basis points to a 2.25%-2.5% range by the end of last year.

The US currency, though, has been quite range bound against the other major currencies in the past year. The euro-dollar rate has largely traded in a narrow $1.11-$1.15 band since last October.

Meanwhile, sterling has generally traded in a $1.26-$1.33 range since mid-2018.

Foreign exchange market positioning has become extremely long on the dollar, which could be a warning sign for the currency. Other factors may also be turning against the dollar.

The US economy is expected to move on to a slower growth path in the coming year, with the Fed likely to start cutting rates in the months ahead, to help sustain the expansion in activity.

Nonetheless, the relative strength of the US economy, wide interest rate differentials and geopolitical uncertainties all remain supportive of the currency.

The persistence of very low-interest rates elsewhere is also making it difficult for other currencies to make ground against the dollar.

Meanwhile, political uncertainty in the EU, the marked slowdown in the eurozone economy as well as the likely further policy easing by the ECB are all headwinds for the euro.

The extent of policy easing by the Fed is likely to be a major factor impacting the dollar over the balance of this year and into 2020.

If the Fed delivers the 100 basis points of rate cuts expected by the market, it is likely to put downward pressure on the currency

On the other hand, modest rate cuts of 50 basis points or less would signal just a modest deceleration in US growth.

The dollar may not lose much ground in these circumstances.

Those in the tourism industry will certainly be hoping that the dollar does retain most of its strength, as it has been a key factor in the big rise in visitor numbers coming to Ireland from the US in recent years.

Oliver Mangan is chief economist at AIB.

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