Dollar Weakness Expected as Fed Nears Policy Easing

Grim Outlook for the US Dollar: An Invesco Perspective

In a report to clients in September, de Longis outlined that his team had strengthened its bearish conviction on the dollar, moving from an "underweight" to a "strongly underweight" rating. This shift was based on two primary factors: a narrowing bond yield differential and unexpectedly positive economic data from outside the United States. The team’s current view is the most negative on the dollar since June 2024.

"While the dollar still enjoys a higher yield than its developed market peers, the expectation that this yield advantage will be eroded is putting downward pressure on the dollar," de Longis wrote. "This provides a potential catalyst for non-U.S. equity outperformance, driven by U.S. capital outflows seeking international diversification and foreign currency appreciation."

Recent Market Movements and Interest Rate Cut Expectations

The U.S. Dollar Index briefly flirted with the 98 level on Wednesday but failed to hold above it, hovering around its daily open. Since then-President Donald Trump's announcement of sweeping tariffs on U.S. trading partners on April 2nd, the Dollar Index has fallen by over 5%. As a result, some investors have begun diversifying their portfolios and increasing hedging against the dollar.

Last week's dismal jobs report solidified expectations that the Fed will cut interest rates next week. The only question in investors' minds is whether the cut will be 25 basis points or 50 basis points. Much of this hinges on how tariffs are impacting prices in the world's largest economy. U.S. Producer Price Index (PPI) data is due out Wednesday, and the Consumer Price Index (CPI) report is due out Thursday.

Data released on Tuesday showed that the U.S. economy may have created 911,000 fewer jobs than previously estimated in the 12 months through March, suggesting that job growth was already slowing before Trump imposed substantial tariffs on imports.

Although the report highlighted cracks in the U.S. labor market, market bets on interest rate cuts remained unchanged, as the data was considered a "backward look." The report didn’t provide any information about job creation since March.

Current Market Expectations

Currently, traders have fully priced in a 25 basis point interest rate cut by the Fed next week and anticipate a 5% chance of a 50 basis point cut. They expect the total amount of interest rate cuts this year to reach 66 basis points.

Kieran Williams, Asia FX head at InTouch Capital Markets, said, "The hurdle for a 50 basis point rate cut is high and would likely require a clear downside surprise in core inflation to provide cover for the doves. Given the stickiness in services prices and the Fed’s tendency to signal gradual changes, a large cut is unlikely next week, but the data will determine how much the market prices in end-of-year easing."

Matt Simpson, a senior market analyst at City Index, also believes a significant cut is unlikely by the Fed, saying, "I think a 50 basis point rate cut right now would do more harm than good for market sentiment. Furthermore, the Fed wants to save face and won’t completely cave to Trump’s desires."

Simpson pointed out, "The market expects the Fed to cut interest rates three times in the next three meetings. The Fed is perfectly capable of meeting those expectations, or adding to the possibility of a rate cut in 2026, without needing to cut by 50 basis points next week."

The Fed's Independence

Investors also welcomed a court ruling that temporarily blocked then-President Trump from removing Fed Governor Cook. The case is likely to eventually make its way to the U.S. Supreme Court. Investors are closely watching this unprecedented legal dispute as it could upend the Fed's long-held independence.