The market expects the Federal Reserve to cut interest rates by 100 basis points during the year, but HSBC believes that this dovish expectation is very aggressive and there is still a possibility of a soft landing. In addition, the dollar has dropped to its lowest level in six months, HSBC believes that the dollar still has room to rise during the year.
After the July non-farm unemployment rate triggered a recession warning, recession trades and rate cut trades continued to alternate, leading to the recent weakness in the US dollar. The majority of the market believes that as the Fed begins a rate-cutting cycle in September, the dollar may continue to weaken. However, HSBC believes that the current exchange rates are undervalued relative to the US interest rate market, suggesting that the dollar may soon experience a rebound.
In a recent research report, analysts from HSBC such as Daragh Maher pointed out that concerns in the market about a US economic recession may be exaggerated. The analysts wrote:
It is expected that the US economy may slow down, as the Federal Reserve has already implemented a policy of monetary tightening. However, we believe that the recession panic triggered by the July non-farm employment report has clearly been exaggerated (and is temporary).
Recent retail sales and other data indicate that the US economy is still on track for a soft landing. It is believed that this will prompt the Fed to cut rates at every meeting for the rest of the year, with one potentially being a 50 basis point cut, totaling 100 basis points for the year. However, HSBC points out:
Unless there is a catastrophic deterioration in the economy, the Fed's actual actions may not be more accommodative than what the market currently anticipates.
Considering the already aggressive market expectations for a dovish Fed policy, HSBC emphasizes that the weakness in the US dollar may have reached its limit. If the Fed's confidence in a soft landing strengthens, the dollar may find support due to a cooling of rate cut expectations. The institution states:
Firstly, even if we consider the market's suggestion that the Fed may cut rates by 100 basis points before the end of the year, the dollar appears overly weak relative to these dovish rate expectations.
Secondly, we do not believe that the macro story in the United States will prove this loose pace to be reasonable, considering the lack of evidence of an impending recession, we believe that a 50 basis point rate cut is unnecessary for a "soft landing" scenario.
Combining these two factors, along with the fact that the US dollar index has returned to its low point in December 2023, gives us a reason to be optimistic about the US dollar.
Pressure on the euro, yen, and other currencies.
Due to the market's aversion to the US dollar, the euro has shown strong performance recently, and the euro to US dollar exchange rate has broken through the high point in December 2023.
HSBC believes that although the European Central Bank's attitude tends to be hawkish, this support for the euro is limited, and if the US dollar regains favor in the market, the euro may come under pressure again.
HSBC predicts that the euro to US dollar exchange rate may fluctuate within the range of 1.1000-1.1276 in the coming weeks. As of the time of writing, the euro to US dollar exchange rate is 1.1069.
For the yen, HSBC points out that although the US dollar to yen exchange rate has fallen from its previous high, this adjustment may have ended. With the market repricing the Fed's policy path, the US dollar has returned to strength, and the yen faces the risk of a pullback.
HSBC also proposes a trading idea to buy US dollars against the Swiss franc at 0.8490, with a target price of 0.8740 and a stop loss at 0.8390.
We have decided to take advantage of our expectations for the rebound of the US dollar to trade the undervalued USD/CHF exchange rate. We believe that the Swiss franc has recently risen too high and too far, and its strength has exceeded the changes in interest rate differentials, which is inconsistent with the previous interest rate differential trades.
Due to Swiss inflation being lower than the Swiss National Bank's forecast, policy makers may have limited tolerance for the strength of the Swiss franc. As two safe-haven currencies, the USD/CHF exchange rate also eliminates some of the uncertainty regarding market expectations of how the Federal Reserve, which may not be as dovish, will react.