The U.S. dollar index, which measures the strength of the dollar against six major currencies, fell by 0.45% to 101.72 as the dollar bears continue to advocate for the Federal Reserve to cut interest rates, resulting in a weaker greenback.
However, Goldman Sachs believes that further evidence of economic stress and tightening in lending conditions is required to justify further weakness in the dollar, given the current modest impact from the banking crisis.
Goldman Sachs stated that the market is approaching the limit of pricing in dollar weakness based on policy divergence and that “clear evidence” is necessary to justify the growing bets on a Fed pivot.
Recent bets on a Fed cut 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,” said MUFG in a research note.
Although Fed Chairman Jerome Powell acknowledged that tighter lending conditions could be a substitute for rate hikes, he added that if the level of tightening was less than expected, the central bank may continue to pursue a higher for longer rate regime.
Goldman Sachs believes that the current level of tightening doesn’t appear to be large enough to provide the amount of restraint the market is pricing, with recent Fed balance sheets showing a reduction in borrowing from the Fed’s lending program.
“Fears 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.
However, some suggest that it is too soon to gauge the full impact of the recent bank failures on lending standards. Signs of diminishing deposits in the banking sector indicate a reduction in lending that could eventually push the economy into recession, forcing the Fed to launch a rescue mission.
Pantheon Macroeconomics expects the first rate cut in September after the Fed delivers its final hike in May, as the recession is anticipated to drive inflation down more rapidly than policymakers expect.
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