U.S. Dollar Forecasts Upgraded as G20 Deal Casts Doubts over Fed's Rate Cutting Resolve

© The White House

- USD seen stronger for longer at Barclays following G20 detente.

- Truce spares U.S. and global economies, eases pressure on Fed.

- Barclays sees less aggressive rate cuts from Fed supporting USD.

- USD awaits Chairman Powell's trip to Washington, eyes guidance.

The Dollar was on its front foot Tuesday as investors pared back earlier bets against it ahead of Federal Reserve (Fed) Chairman Jerome Powell's eagerly-anticipated appearance before Congress, but analysts at Barclays say the U.S. currency will continue to dominate rivals for a while yet. 

Jerome Powell, the Trump-appointed head of the Federal Reserve, will update Congress on Wednesday and Thursday on the bank's assessment of the U.S. economic outlook as well as its current thinking on monetary policy and some in the market are growing nervous about what he could say.

"Sterling is leading the G7 FX space lower today as technical selling appears to be taking over ever since the market broke back below the 1.2500 level.  The “Fed rate-cut trade” continues to get dialed back as we await comments from Jerome Powell," says Erik Bregar at Exchange Bank of Canada. 

The testimony will come at a pivotal time for the Dollar, which has been buoyant this week after June's payrolls report allayed fears of an imminent turn for the worse in the jobs market and economy. A tariff-related ceasefire agreed between the U.S. and China at the end of June has also lifted the greenback.

As a result, financial markets are behaving as if they're less certain than they were just one month ago about their new bets on the Fed, which had seen investors wagering the U.S. central bank would cut its interest rate three times before the year is out, leaving the Fed Funds rate at 1.5%-to-1.75%.

Now, and in the wake of last Friday's nonfarm payrolls report and the June G20 agreement between Presidents Donald Trump and Xi Jingping to avoid new tariffs on each other and to return to the negotiating table, analysts at Barclays have upgraded their Dollar forecasts. 

Above: Dollar Index at 4-hour intervals, annotated for recent events. 

"While we still expect the Fed to ease in the face of persistently low inflation, sizeable external risks and a moderation of US growth, we think the intensity of cuts and the risks to the path have moderated," says Marvin Barth, head of FX strategy at Barclays. 

President Donal Trump had threatened to put tariffs on more than $300 bn of China's annual exports to the U.S. each year if it didn't agree to a deal addressing its "unfair trading practices", after already having lifted from 10% to 25% the tariff levied on $250 bn of goods trade with the U.S.

The May use of company 'blacklists' against each other marked the beginning of a descent from trade dispute toward all-out economic conflict, which hurt business confidence and economic growth the world over including in the U.S. 

As a result, the G20 agreement has seen analysts become less pessimistic in their outlook for the U.S. and global economies, which is likely to mean the U.S. continues to grow at a faster pace than many economic rivals and that other economies, like the Eurozone, can avoid a more protracted slowdown than what they've seen already.

Above: Pound-to-Dollar rate shown at daily intervals.

"We now see a more persistent but shallower path of USD appreciation, as there is less negative bite from US interest rates in the near term and less of a rise in non-US risk premia, given the improved global outlook. Specifically, we have moderated the path of EURUSD to flat in the next quarter and a low of 1.08 (previously 1.06) in Q2 20," says Barth. "Our [GBPUSD] forecast has risen to a low of 1.23 mid-2020, from 1.20."

Barclays had as recently as June, looked for the Dollar to weaken modestly going into September, which is when the bulk of the Fed's 0.75% worth of interest rate cuts was expected to be delivered, before rising steadily thereafter. 

That was forecast to lift the Euro-to-Dollar rate up to 1.14 by the end of September and to help keep the Pound-to-Dollar rate steady around its then-level of 1.27. However, both exchange rates are now expected to remain under pressure for a while to come. 

Barclays projects the Pound Euro-to-Dollar rate will fall to 1.24 by the end of September, where it's likely to remain until March 2020 before slipping further to 1.23. Meanwhile the Euro is seen falling to 1.12 by the end of September before ending the year at 1.10. It then falls to 1.09 and 1.08 in March and June 2020

Above: Euro-to-Dollar rate shown at daily intervals.

The Fed lifted U.S. borrowing costs four times in 2018, leaving the Fed Funds rate range at its current 2.25%-to-2.5%, boosting the appeal of U.S. assets in the process and helping to lift the Dollar by 4% against rivals that year. It's raised rates nine times since the end of 2015.

Fed Chairman Jerome Powell said in June speech the bank would do whatever is necessary to sustain the current U.S. economic expansion but that policymakers shouldn't respond to developments that might turn out to be temporary, which could have been a reference to either a 2019 fall in inflation or that month's payrolls number. The comment could have also referred to both.  

Powell's remarks came just after markets ramped up their bets the Fed would cut rates this year, and were followed by comments from Federal-Open-Market-Committee 'dove' James Bullard, who said last month that bets on three rate hikes were "overdone".

Inflation figures due out on Thursday after Powell's first testimony to Congress could yet complicate any move to reduce borrowing costs for companies and consumers. Price pressures have waned in 2019 but Fed Chairman Powell and private sector economists have warned the decline could be temporary. 

Changes in rates are only normally made in response to movements in inflation, which is sensitive to economic growth, but impact currencies because of the influence they have on capital flows and their allure for short-term speculators.

Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

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