figure 1.
Real interest rate differentials add another layer to the dollar’s narrative. In the near term the dollar is also expected to weaken due to falling Inflation. Inflation is expected to fall faster in other developed economies when compared to the U.S, as supply side constraints ease inflationary pressure outside the U.S. As such America’s peers may be able to cut interest rates more aggressively, thereafter the increase in the interest rate differential could see the dollar weaken against other developed market currencies.
Looking ahead to 2024, the spectre of rate cuts looms over the dollar. Rate cuts in 2024 will weigh on the dollar, the Fed’s FOMC median dot plot is pricing in 75-bps worth of cuts. However, this is a conservative figure compared to what the market is pricing in as depicted in figure 2. This discrepancy sets the stage for a significant headwind, as substantial rate cuts are poised to be a driving force behind the dollar’s anticipated depreciation throughout the year.
Adding to the dollar’s challenges for 2024 is its perceived overvaluation. History shows us that an overvalued dollar precedes a relative weakening of the world’s reserve currency
figure 2.
over the next 5-10 years as investors demand a discount via higher interest rates or a lower exchange rate. In this scenario, investors seeking a discount may find a more viable avenue through a lower exchange rate, particularly as interest rates appear destined for a reduction.
However, this is not to say that the dollar will not experience any upside in 2024, because despite these prevailing headwinds, opportunities for the dollar’s resurgence in 2024 should not be dismissed. Due to the extreme liquidity of the greenback, thanks to its status as the global reserve currency, the dollar benefits during times of geopolitical uncertainty. Such as the geopolitical uncertainty seen in 2023 due to the ongoing war between Russia and the Ukraine as well as the Israeli-Hamas conflict in Gaza, which look set to continue in 2024, resulting in market volatility and uncertainty. Both are catalysts that prompt investors to seek the safety of the dollar, offering potential intermittent relief from its overall downward trajectory.
In summary, the dollar’s trajectory for 2024 is a nuanced interplay of global economic conditions, real interest rate differentials, anticipated rate cuts, and perceptions of its overvaluation. While a shallow recession may temporarily support the dollar, these headwinds are likely to prevail. However, the dollar’s extreme liquidity and its role as the global reserve currency could lead to periodic upside, especially during times of geopolitical uncertainty, as witnessed in 2023. In 2024, ongoing conflicts may contribute to market volatility, prompting investors to seek the safety of the dollar despite its overall downward trajectory.
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