Fasten your seatbelts: there goes the dollar

The euro-dollar exchange rate has been quietly bubbling along this year. That will soon change, however, as the US election campaign heats up and the Federal Reserve takes action. But first, it is the European Central Bank's turn.

There will be just over 2024% between the lowest and highest euro/dollar exchange rates in 5. For most companies, such a difference would take a big bite out of profitability. But it is child's play compared to the currency shocks in other years. In the summer of 2022, for example, the euro started a slide of more than 20%. But it also happened regularly that the euro rose by 10% or more against the dollar within a few months. There is a good chance that the calm, rippling exchange rate trend is the calm before the storm. It is only a matter of days before the American interest rate cut that currency markets have been preparing for for a long time finally comes.

Did the Fed miss the boat?
Traders are closely following developments in the American labor market. Unemployment is slowly but surely creeping up on the other side of the Atlantic. If employees are no longer certain that they will immediately find another job if they are laid off, they will become somewhat more reluctant to spend money. Falling consumer spending is often a prelude to a recession. Some parties are therefore afraid that the Federal Reserve is already too late with the interest rate cut. For the time being, the American economy seems to be keeping up reasonably well, so that a cut of 0,25 percentage points to 5% seems the most obvious option.

Interest rates can fall quickly
But what matters most is what happens after next Wednesday’s interest rate decision. According to forecasts as tracked in CME FedWatch, economists expect the policy rate to gradually decline to 3% in the summer of 2025. In addition to falling interest rates, political uncertainty could also play havoc with the dollar for the time being. If it turns out in November that Donald Trump is allowed to return to the White House and that his Republican Party wins a majority in both the Senate and Congress, the pressure on the dollar could quickly fade. Trump plans to implement tax cuts, which could have a positive effect on the American economy.

Popcorn is ready
In this scenario, the dollar is also popular as a safe haven, in the event of a flaring up of the trade war with China and the scaling back of military aid to Ukraine. On the other hand, a victory for Democratic Kamala Harris could cause the dollar to take a few steps back. Under her administration, higher taxes could put a brake on economic growth. To prevent unemployment from rising too much, the Federal Reserve will cut the policy rate a bit further than the market is currently pricing in. The debate between Trump and Harris tonight therefore offers a nice insight into the direction the dollar will take in the coming period. I'm getting the popcorn ready and fastening my seatbelts for an interesting dollar ride in the coming months.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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