Dollar Set to Weaken Amid Rising Concerns

A recent survey of foreign exchange analysts suggests the US dollar is poised for a steady decline in the coming months. This projection stems from mounting worries regarding the Federal Reserve's independence, the credibility of official statistics, ballooning fiscal debt, and increasing bets on interest rate cuts.

Highlighting these concerns was the dismissal of the Bureau of Labor Statistics chief by the previous US president over unsubstantiated accusations of "data manipulation." This followed a record downward revision in jobs data, swiftly reversing recent dollar gains triggered by a trade agreement with the European Union.

Despite a moderate pullback in crowded short-dollar trades, the dollar has already depreciated nearly 9% against a basket of major currencies this year. The previous president's erratic trade policies, repeated attacks on the Fed and its chairman Jerome Powell, and rising debt levels have prompted investors to reconsider holding US assets, pushing up the term premium – the compensation demanded for holding longer-dated debt.

Expert Views on the Dollar's Future

Forex strategists reflected this sentiment in polls conducted from August 1-5. They have maintained a bearish outlook on the dollar since at least April, forecasting the euro to rise about 2% to $1.17 by the end of October, and to continue climbing to $1.18 in six months. Subsequently, the euro is projected to rise to $1.2 in a year, the highest median forecast seen in the survey since October 2021.

Erik Nelson, head of G10 foreign exchange strategy at Wells Fargo, stated, "We have been in a 'U.S. exceptionalism' trading environment, where the U.S. was by far the strongest economy in the world. But that, in my view, is no longer the case. There are underlying structural concerns – the Fed's independence, data quality, you name it. From an economic backdrop, all of that is moving in the wrong direction. The market's primary inclination for the foreseeable future will be to 'sell the dollar on rallies'."

Concerns Regarding Accuracy of Government Data

In a separate Reuters poll, as many as 89 out of 100 top policy experts expressed concerns about the accuracy of US government statistics days before the dismissal of Erika McEntarfer, chief of the Bureau of Labor Statistics.

Federal Reserve Independence Under Scrutiny

The previous president's repeated attacks on Powell have further heightened investor nervousness. So far, Powell has resisted pressure to implement substantial rate cuts. Furthermore, the early resignation of Fed Governor, Kugler, could unsettle an already fractious Fed leadership transition. Powell's term as Fed chair ends in May of next year.

Francesco Pesole, FX strategist at ING, stated, "If the previous president installed one of his nominees as governor, and then that person possibly gets elected as chair next year – I think the market would react quite badly to that. Naturally, there will be a lot of investors watching how many members turn dovish, or whether they remain cautious and fail to align with the new dovish chair. If the market thinks that the Fed's independence has been materially damaged, that would be a very powerful argument for dollar weakness."

Market Expectations for Rate Cuts

Currently, interest rate futures markets are pricing in around three rate cuts by the Fed by the end of this year, with the first move expected in September. This represents a sharp increase from expectations just weeks ago of only one or two cuts, while market expectations for rate cuts by the European Central Bank are only for one or none at all.

Although a still-robust US economy and tariff-driven inflation risks have curtailed some of the dollar's losses – dollar net short positions had reached a two-year high at the end of June – the dollar's slide may only slow, not reverse.

The survey showed that over 60% (26 of 42) of strategists expect dollar net short positions in Commodity Futures Trading Commission (CFTC) data to increase or remain steady by the end of October.

But the minority view is also growing, with over a third of respondents now forecasting net short bets will decrease, compared to just 17% in July. Jason Draho, head of Americas asset allocation at UBS Global Wealth Management, said:

"Shorting the dollar is one of the most consensus trades this year, with most investors still expecting longer-term depreciation to persist. But the short-term view has become less bearish, so positioning is more likely to move towards a reduction in net shorts over the coming months."

Additional Considerations: Geopolitical Risks and Global Economic Slowdown

Beyond the factors mentioned, geopolitical risks and a potential global economic slowdown could also influence the dollar's trajectory. Increased global uncertainty often drives investors towards safe-haven assets like the US dollar, potentially providing temporary support. However, a significant global slowdown could negatively impact US economic growth, further weakening the dollar in the long run.