Is it too early to count the US dollar out?

While many analysts still expect the US dollar to lose ground over the long haul, the near-term is unlikely to see the greenback shed substantial ground. On growth, we have to bear in mind that the US is undergoing an investment boom due to AI-related data centre construction. The problem is that much of the data that shows the extent of this investment surge does not show through in the month-to-month numbers that attract financial market interest.

If we take consumer spending, such as the weak retail sales report, there is little doubt that the consumer is still the key driver of the economy, as it accounts for up to 70% of GDP. So, the fact that there is some vulnerability, especially lower down the income scale, is of concern.

However, when this weakness is counterbalanced by strength in investment, the hit to GDP is not so substantial. Right now, the Atlanta Fed GDP Now the estimate for Q3 stands at a very solid 4.3%. That might prove too high when the official data are released in a few months' time but, even so, the numbers hint that it is too soon to write off the US.

If we look at payroll data, which has been seen as disappointing recently, we need to bear in mind that workforce growth is so poor that even small declines in employment, as we saw last time, can still be consistent with a stable unemployment rate. The bottom line is that the economy is not in a parlous position that undercuts the outlook for the US dollar.

In a similar vein, Steven Barrow, Head Strategist of the Standard Bank, thinks it is wrong to suggest that the Fed will be able to avoid a rate hike or hikes. Expectations for tighter policy have been pared back by inflation data that has come through on the lower side of expectations just recently. But a few months of data does not make a trend.

“We think that the most the soft inflation data now can do is to push back the time at which Fed members decide to hike rates. Many members have already suggested that rates need to rise and we do not think that the odd low CPI print is going to shake this view. We doubt that the hawks will have sufficient numbers to push through a rate hike at the next meeting in September but one or two rate hikes still forms our base case for late 2026 or the early months of 2027”, said Steven Barrow.

Another point is that new Fed Chair Warsh seems determined to keep the market in the dark when it comes to the possibility of policy changes. Fewer Fed speeches, less policy guidance and, possibly in the future, no FOMC forecasts all go into the mix suggesting that greater Fed policy surprises will be the order of the day and, if these surprises come in the form of rate hikes, as we would expect, they could work to the benefit of the dollar.

This being said, Steven Barrow does not believe that surprise hikes from the Fed will generate significant and long-lasting strength in the US dollar. Instead, he anticipates the odd surge in the US dollar as surprise rate hikes occur but would also expect this strength to unwind in subsequent weeks and months. That's because Fed rate hikes at this stage seem more likely to be driven by the Fed's frustration about overshooting inflation, and not as a consequence of severe demand-led pressure through fast GDP growth.

“We feel that rate hikes driven more by the inflation side of the Fed's mandate than the employment side are less likely to produce any sustainable strength in the US dollar. This view does not just apply to the Fed. The ECB hiked rates back in June in response to overshooting inflation, not robust economic growth, and the consequence has been that the euro has shed ground in trade-weighted terms. If we put all this together, it suggests to us that euro/US dollar is not going to stray too far from 1.15 in the short-term with US dollar/yen similarly constrained around the 160 level. In time, we do think that the US dollar will cede ground but that's for the long haul, not for now”, Steven Barrow forecasted.