Doha: QNB has forecasted a move towards a more “moderate” level for the US dollar, supported by fiscal consolidation measures, additional monetary easing, and the new US administration’s focus on addressing imbalances.
According to Qatar News Agency, in its weekly report, QNB indicated limited potential for further appreciation of the US dollar beyond current levels. The report noted that few indicators reflect global macroeconomic trends as accurately as currency fluctuations, particularly in the deep and liquid foreign exchange markets of major advanced economies, such as the US dollar, Japanese yen, euro, Swiss franc, and British pound.
Foreign exchange rates depend on capital flows, which are influenced by immediate reactions and expectations related to risk appetite, relative economic performance, and interest rate differentials. The report highlighted significant volatility in major foreign exchange markets in recent months, with the US Dollar Index (DXY) rising by approximately 6% since September 2024 following Donald Trump’s victory in the US presidential election in November 2024. This rapid movement in the US dollar reflects unusual volatility, coinciding with cyclical equity returns in the US market.
The report pointed out that the US Dollar Index surpassed critical levels witnessed in September 2023, coinciding with the “peak” tightening measures implemented by the Federal Reserve. As a result, analysts and investors have begun discussing the expected direction of the US dollar. Several economic analysts and investors believe that the US dollar should be well-supported by increased tariffs on major trading partners imposed by Trump, the strong performance of the US economy, and the likelihood of the Federal Reserve having to act more cautiously on monetary policy compared to its counterparts, due to rising inflation in the United States.
The report considered that the US dollar’s valuations are exaggerated, but analyses suggest that these valuations may require adjustment. Data on the real effective exchange rate for December 2024 shows that the US dollar is the most overvalued currency among major advanced economy currencies, with valuations exceeding its theoretical fair value by 21.8%.
The report suggested that there is room for a scenario beyond the idea of a “strong dollar” in the long term, pointing to two factors supporting its view of potential headwinds for the dollar in the medium term. The first factor is that shifts in the fiscal stance of major advanced economies could narrow growth and interest rate differentials with the United States. In recent years, the United States has been bolder than its counterparts in implementing expansionary fiscal policies, helping boost its economic performance. However, this has resulted in a deficit increase to about 7% of GDP.
Currently, with the new US economic team preparing to implement significant fiscal consolidation to reduce the deficit to 3%, while other advanced economies adopt more expansionary measures, the US economic growth advantage may begin to wane. Ultimately, narrowing growth differentials will favor other currencies over the US dollar.
The second factor noted that despite uncertainties about the path of US interest rates and the belief that monetary easing “has ended,” the report anticipates that the Federal Reserve will carry out at least two more rate cuts in 2025. The report concluded that a significant downward trend in non-cyclical inflation, slowing economic activity, and a flexible labor market in the United States could lead to further rate cuts until they reach neutral levels, affecting interest rate differentials between the US and other economies. This would, in turn, facilitate global financial conditions and stimulate capital flows towards non-USD assets.