The Federal Reserve is expected to kick off its long-awaited shift in US monetary policy soon and that will likely mark “the beginning of the end” of the ongoing dollar rally, according to analysts.
Globally, the battle against inflation is not over, but recent market surprises have come from lower-than-expected inflation prints in Norway, Sweden, and the US.
Next week, UK inflation data is due, with the consensus expecting headline inflation to slow to 1.9% from 2%, while the core measure is expected to remain at 3.5%, continuing to cause some concern for the MPC.
“If the numbers play out as expected, the FX market will probably assume a base case of rate cuts in both the UK and US in September, but the stickiness of UK inflation could translate into a further push higher in GBP/USD,” analysts at Societe Generale (OTC:SCGLY) said in a note.
This inflation stickiness in the UK is not positive news but rather a consequence of 'doing' Brexit at the onset of a global pandemic, which caused significant supply-side price shocks exacerbated by political actions.
Historically, the dollar hasn’t reversed on the first rate cut, so one may expect a more challenging second half of the year.
“However, this episode of dollar strength has been so powerful and accompanied by such enormous capital flows, that a decent-sized correction is inevitable at some point,” analysts continued.
The yen, which has been significantly weakened, exemplifies the dollar's strength. The USD/JPY pair has recently diverged from the trajectory of US yields, and the two are likely to realign.
A drop in USD/JPY to 150 wouldn't be surprising, analysts noted, though it would not confirm the end of the dollar's supremacy either.