Rabobank Forecast Update: Central Bank Race to the Bottom Dethrones King Dollar

Modified: Monday, 15 July 2019 16:38 BST
Written by: James Skinner

- 'King Dollar' likely winner in central bank race to the bottom.

- Falling USD dictates exchange rate trends in the year ahead.

- GBP/EUR bottom is in but GBPUSD to see one last leg lower.

Pound Sterling could embark upon a gradual recovery from recent losses in the months and quarters ahead after 'King Dollar' is dethroned by the Federal Reserve (Fed) amid an ongoing central bank race to the bottom of the interest rate ladder, according to the latest forecasts from Rabobank.

A falling Dollar and the exact pace of decline will be the main trend setter in the currency market over the next year, the latest Rabobank forecasts suggest, as the Fed is close to calling time on its four-year interest rate hiking cycle.

The Fed is widely expected to cut its interest rate from 2.5% to 2.25% at the end of July and to slash borrowing costs for companies and consumers again in September, leaving U.S. interest rates some 50 basis points lower than they were at the start of the year.

Those rate cuts and the resulting dethroning of 'King Dollar' have long been anticipated by analysts but what was once a simple narrative of Dollar decline for 2019 and 2020 is now being complicated by the insertion of rate cuts from other central banks into the plot line.

"Despite the market’s preoccupation with US monetary policy, the DXY dollar index has struggled to break free of levels traded at the end of 2018. The simple explanation for this is that other major central banks have also turned dovish," says Jane Foley, head of FX strategy at Rabobank. "Looking ahead, the dovish tone of other central banks will remain a constraint on USD downside."

Central banks in New Zealand and Australia have already cut their interest rates this year following decisions that were also to some extent anticipated quite a while back but that are nonetheless complicating the big Dollar's path lower.

However, the plot truly thickened in June this year when European Central Bank (ECB) President Mario Draghi warned that the world's second largest underwriter of price and economic stability would soon take action if the outlook for Euro area inflation does not improve.

Draghi specifically mentioned interest rate cuts to levels even further below zero and another quantitative easing program are both within the toolbox it will be using in order to encourage the Eurozone consumer price index back to its target of "close to but below 2%".

"The RBA and the RBNZ have already cut rates this year and we expect a reduction in the ECB’s discount rate in September. As a consequence the impact of the softening in Fed policy guidance on the USD has been countered," Foley says.

Improving odds of the ECB launching its own stimulus program at the same time as the Federal Reserve and other developed world central banks are cutting rates has got analysts fearing a 'race to the bottom' and 'currency war' up ahead, particularly as far as the Fed and ECB go.

This is because with Euro-Dollar trade accounting for so much of turnover in the currency market, one can only fall if the other is able to rise. As a result, victory in this race will be denoted not only by the amount of interest rate cuts delivered but also the degree of losses wracked up by the relevant currency.

The Fed is best positioned to win the forthcoming tug-of-war on both counts because after having lifted its interest rate nine times since the end of 2015, it has significant scope to lower borrowing costs by a meaningful amount in the months ahead. And with the Dollar having bested most rivals last year, many have long looked for a decline.

"The slowdown in global economic growth suggests that clouds have been gathering. Looking ahead, in our view there is risk of an escalation in the trade tensions between the US and China and this is a significant risk to the global economy and to risk appetite. There is plenty of commentary stemming from Washington regarding a desire on the part of the US to contain the growth of China both on an economic and a military levels," Foley warns.

Below is a table detailing what all of this could mean for the major exchange rates next year, alongside a selection of views for individual currencies.

The Dollar index was quoted 0.14% higher at 96.93 Monday and is now up 0.95% for 2019 overall. The Pound was 0.40% lower at 1.2510 against the Dollar and is down 1.8% in 2019, while the Euro-to-Dollar rate was down 0.08% at 1.1257 and is down -1.81% this year.

Above: Rabobank G10 exchange rate forecasts Vs U.S. Dollar, July 2019.

Pound Sterling

"GBP is clearly vulnerable against a backdrop of political uncertainty and a deteriorating UK economic environment...Additionally, data are showing that the UK economy is slowing. Q1 data were shored up by stockpiling ahead of the original March Brexit resulting in a sharp slowing of activity in Q2. The Brexit outcome and politics developments remain the largest driving factor for GBP."

Above: Rabobank BP forecasts.

U.S. Dollar

"Against the backdrop of slowing world growth the market is poised for what could be the start of an easing cycle by the Fed. That said, the dovish stances of most other G10 central banks is offsetting the impact of potential Fed action on the USD crosses."

See table above and at linked webpage.

Euro

"We expect the ECB to cut its discount rate further into negative territory at its Sep meeting. Additionally there is underlying demand for the USD which stems from its dominance in the international payments systems...That said, we expect upside pressure on EUR/USD to increase in 2020 on anticipation of a step up in the pace of Fed rate cuts."

See table above and at linked webpage.

Australian Dollar

"The RBA has become the most dovish G10 central bank by cutting rates twice already this year...Against the backdrop of a sharp drop in Australian bond yields, the risk of QE is being discussed in the context of the RBA going forward...We see scope for further RBA policy moves and expect further downside potential for AUD/USD."

See table above and at linked webpage.

New Zealand Dollar

"The RBNZ was the first G10 central bank to cut rates this cycle and it has warned that more stimulus is in the pipeline, with August widely expected to bring a policy move...While NZD/USD has found some support from Fed rate hike expectations, we see downside potential medium-term on risk of an escalation in China/US trade wars and a broad decline in risk appetite."

See table above and at linked webpage.

Canadian Dollar

"USD/CAD peaked at 1.3565 on the last day of May but the pair fell 3.9% by early July...There is likely too much easing priced into the USD for the rest of the year and too little risk of easing from the BoC so a repricing should push the pair higher. That said, higher oil prices are likely to provide an offset so we remain only moderately bullish USD/CAD."

See table above and at linked webpage.

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