USD weakness continues - Commerzbank

Since the middle of last week, the USD has weakened day by day, causing higher EUR/USD levels. There is still no sign of anything on the EUR side that could contribute to this movement, Commerzbank's Head of FX and Commodity Research Ulrich Leuchtmann notes.

A USD-negative view is justified

"The market considers a large 50-basis-point move by the Fed at tomorrow's meeting to be increasingly likely (now more likely than a small 25-basis-point step), and that has taken its toll on the USD. A large move does not necessarily imply that the rate-cut cycle will end lower than the market had previously expected. A terminal rate of around 2¾ % is still the scenario priced in by the market. And yet a more aggressive start to the rate cuts is rightly seen as USD-negative."

"We have recently tried to show that (1) inflation expectations point to the 2% inflation target being reached, but so far there is no evidence of a significant undershoot. And we showed (2) that the US labor market has cooled, but continues to perform almost as well as in the goldilocks year of 2019. Sure, there are risks. The labor market could cool down rapidly, and of course inflation could plummet. But of course, things could also turn out differently."

"A 50-basis-point move would suggest that the Fed's reaction function is more negative for USD than could be assumed just recently. And that would not only be relevant for the current interest rate, but would increase the risk that in the future the Fed would be more likely to cut rates in case of doubt. This basically confirms our USD-negative view: in interest-rate-cutting cycles, the Fed is more aggressive than most other central banks. Such phases tend to be USD-negative because they make the dollar appear riskier. A higher risk premium on USD positions, i.e. a weaker US dollar, is the logical consequence."