Dollar’s slide on rate-cut bets nearing limit as economic stress coming up short By Investing.com

By Yasin Ebrahim

Investing.com – The dollar bears have been beating the Federal Reserve rate-cut drum, dragging the greenback lower but that tune may soon be out of rhythm should the economic impact from the banking crisis remain modest.

The , which measures the greenback against a trade-weighted basket of six major currencies, fell by 0.45% to 101.72.

More evidence pointing to economic stress and tightening in lending conditions — following the banking crisis — is needed to justify pricing in further dollar weakness on expectations for a less hawkish Fed, Goldman Sachs said.

“We think we are approaching the limit on the amount of dollar weakness that can be priced on the back of policy divergence,” Goldman Sachs said, adding that “clear evidence” was needed to justify the growing bets on a Fed pivot at a time when banking crisis appears to be under control.

Growing bets on a cut have pushed the federal funds rate more than 100 basis points lower than before the bank failures, according to Goldman Sachs. The bets on a Fed pivot reflect the market’s view that “the tightening in credit conditions will do the Fed’s job so that they no longer have to raise rates much further to make them more confident that inflation will fall back to their target,” MUFG said in a note. 

At his monetary policy press conference in March, Fed chairman Jerome Powell said tighter lending conditions could be a substitute for rate hikes, though added that if the level of tightening was less than expected, then the central bank may continue to pursue a higher for longer rate regime.

But the tightening from what has transpired so far doesn’t “appear to be large enough to provide the amount of restraint the market is pricing,” according to Goldman Sachs. Recent Fed balance sheet showing that banks reduced borrowing from the Fed’s lending program gives credence to that view. 

“[F]ears over the health of US regional banks will have been eased by the release of latest balance sheet data that revealed a reduction in the usage of liquidity windows to support banks,” MUFG added. 

Others suggest that while it may be too soon to fully gauge the impact on bank lending standards from the recent bank failures, signs of diminishing deposits in the banking sector point to reduce lending that will eventually push the economy into recession and force the Fed to launch a rescue mission.

“The recession will drive inflation down more quickly than policymakers expect, so we expect the Fed to respond by cutting rates, but not immediately,” Pantheon Macroeconomics said, forecasting the first rate cut in September after the Fed delivers its final hike in May.