📝 U.S. Dollar to Benefit From Shift In Rate Expectations: Nordea

The Fed’s bias toward getting ahead of downside risks increases the likelihood that monetary policy could be too accommodating compared to economic conditions. Broad economic measures point to strong economic activity and private sector balance sheets are in a healthy position to respond to more favorable borrowing incentives. Increased borrowing growth at this stage of the economic cycle together with already strong economic growth would risk reigniting inflation. Interest rate cuts are great news for the economy today, but it does increase the likelihood that inflation will reignite down the road. This has had a straightforward implication for the financial market: Stocks have outperformed bonds. Bonds have sold off because the outlook reduces the probability that the lofty interest rate cut expectations are going to become a reality. The interest rate curve has also steepened in anticipation of higher economic growth and inflation down the road. The expectation of an aggressive interest rate cutting cycle hurt the US dollar, but that downward pressure is now in the rearview mirror. Looking ahead, the US dollar is likely to benefit from a growing interest rate advantage when expectations of interest rate cuts decrease or from strong economic activity if the interest rate cuts that are already priced into the market come and are too accommodative and stimulative to the economy. In the euro area, the European Central Bank (ECB), just confirmed that rapid interest rate cuts are coming, because risks are to the downside in the economy, which suggests that risks are to the downside on where the policy rate will end next year. - Nordea