Green shoots emerging for dollar comeback as Fed unlikely to cave into rate cuts

Investing.com -- Dollar bears look set to chalk up a second monthly victory of bets against the greenback, but some see green shoots sprouting for the battered currency on bets that the Federal Reserve is unlikely to cave in to pressure to cut rates later this year.

 The U.S. dollar index, which measures the greenback against a trade-weighted basket of six major currencies, fell 0.47% to remain on track for a second straight monthly loss. 

“We see a moderately stronger USD from here – we expect the broad dollar index to rise by up to 5% in H2 (second half of the year),” Oxford Economics said in a recent note.

The expectations for a dollar comeback later this year, Oxford Economics adds, is driven by expectations that the “Fed won't pivot in H2.”

Expectations for a pivot Fed have helped bring the hammer down on the dollar, pushing it to one-year lows earlier this month.

But recent economic data pointing to still sticky inflation and a banking crisis that hasn’t been as bad as many feared so far, has forced many to reassess their dovish forecast on Fed rate cuts, pushing Treasury yields higher from recent lows. 

Markets expectations for a rate hike on May 3 are now almost fully priced in, according to Investing.com’s Fed Rate Monitor Tool, while just one rate cut is currently expected in 2023. That is a far cry from the 100 basis points of rate cuts that were priced in just a month ago when the banking crisis emerged.

The euro, which makes up about half of the weighting in the broad dollar index, could also play a role in the dollar’s rebound, Oxford Economics adds, as markets are putting too much faith in the European Central Bank keeping rates higher for longer.

“The market is too sanguine on the prospects for elevated policy rates in the Eurozone…beyond 2023 even if inflation is proving to be stickier at the moment,” Oxford Economics said.

But others, however, believe the move away from bets on Fed rate cuts would provide limited runway for the greenback to rebound as a Fed pause after May remains the overarching consensus.

The scope for U.S. Treasury yields to continue moving higher from here should prove more limited, MUFG said, pointing to recent remarks from Fed members showing a somewhat tepid appetite for further hikes beyond May 3.

“Recent comments from New York Fed President Williams signaled that he would be comfortable with the Fed delivering just one more hike then pausing their hiking cycle,” MUFG added.