The decline in interest rates and the rise in stock prices have created a positive environment for risk-sensitive currencies and a negative environment for the safe-haven US dollar. The unexpected election in France has complicated the picture by adding new downside risks to the Euro area and the common currency. This political risk has propelled risk-sensitive currencies to their strongest level versus the euro this year. In addition, the political turmoil has weakened the euro versus the dollar, even though the broad market rally in stocks and bonds has put downward pressure on the safe-haven US dollar. Looking ahead, the dollar is likely to strengthen to its strongest level this year as it becomes evident that the Federal Reserve will keep monetary policy tight and that the European Central Bank will continue its gradual interest rate cutting cycle. The outlook for a stronger dollar and fewer interest rate cuts will likely put downward pressure on the risk-sensitive currencies that have priced in a lot of good news and are trading close to their highest level this year.
Falling interest rates could help stocks reach new record-high levels, but after a significant bond rally in the second quarter it is hard to imagine that interest rates can fall much more on a sustained basis, without it being produced by negative economic news, which would be bad news for stocks that reflect a strong economy. The bearish outlook is likely to create a positive environment for the safe haven US dollar and negative environment for risk sensitive currencies that are close to their strongest level this year. Fewer than expected interest rate cuts from the Federal Reserve and a continuation of the European Central Banks gradual interest rate cutting cycle is likely to strengthen the US dollar to its highest level this year. - Nordea
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