Fed Seals Dollar's Fate: Lloyds
- Written by: Gary Howes
Above: The dollar index - a broad measure of USD performance - has come under pressure over the past 24 hours.
The cards are stacked against the dollar.
Lloyds Bank says the latest Federal Reserve decisions have further weakened the greenback’s fundamental backdrop, leaving little space for renewed dollar strength.
The bank argues that the Fed's shift into what Chair Jerome Powell described as the neutral range reduces the prospect of policy support for the currency.
Strategists at Lloyds say the macro mix now facing the dollar is unfavourable, given the combination of a softening labour market, subdued inflation pressures and uncertainty over incoming Fed leadership.
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The Fed lowered the Funds rate by 25 basis points on Wednesday, while Chair Jerome Powell expressed concerns about the strength of the U.S. labour market. Analysts we follow are describing the event and guidance as 'dovish' as it raises the prospect of further rate reductions next year.
"With a weak labour market," the Fed won't radically shift bias, says Lloyds.
A constraint on further rate cuts would be strong inflation surprises in upcoming data. But analysts at Lloyds say any inflation surprise would more likely force the committee to "show more tolerance for faster inflation in the first instance" rather than return to tightening.
This dynamic could steepen the yield curve (i.e. long-dated bond yields rise as investors demand a greater premium for holding debt that will be eroded by inflation), but "that is not an evolution that ought to suit the dollar".
Lloyds also highlights what it describes as a "very skinny" dollar risk premium, arguing the currency has “eked out as much of a recovery as it can over the summer".
Geopolitical tensions, displayed in what the bank calls a "visceral reminder of the trust issues that work against U.S. exceptionalism", are also seen eroding support for the dollar.
The report points to structural imbalances in the US economy, including labour market fragility, a capex squeeze and weakness in housing, which together could "require lower policy rates".
Lloyds argues that such a scenario would push the remaining dollar premium into deficit and "create the required conditions for another repricing".
It says this would mark a continuation of the broader downtrend in the dollar, as a weaker currency supports global growth and generates non-U.S. investment opportunities.
While acknowledging vulnerabilities in other economies, Lloyds says it continues to favour EUR, NOK, CHF and AUD against the greenback.
