Investing.com — The U.S. dollar is expected to come under increasing downside pressure in the coming months, despite a recent rally fueled by better-than-expected economic data.
UBS analysts say the outlook for the US currency remains negative, with factors including narrowing interest rate differentials, concerns about the growing US budget deficit and changes in global monetary policy all contributing to the situation.
In lightweight of these factors, UBS has downgraded the US dollar to “least preferred” in its global strategy, favoring currencies such as the euro, British pound and Australian dollar instead.
The US dollar gained some ground on Thursday following the release of revised second-quarter GDP growth data.
“Meanwhile, second-quarter GDP was revised up to a 3.0% annual growth rate from the previously reported 2.8%, driven mainly by stronger consumer spending,” analysts said.
The revision was largely due to a rise in consumer spending, which also saw an upward revision from an initial 2.3% to 2.9% year-on-year.
The positive data helped the U.S. dollar rebound slightly, but it remains under pressure. It is down 3% over the past month and has remained near the lower end of its range since the start of 2023.
Despite this momentary relief, UBS analysts maintain that the overall outlook for the dollar is negative and that it could weaken in the coming months for several reasons.
One of the key factors likely to impact the US dollar will be the expected narrowing of interest rate differentials.
The U.S. Federal Reserve is likely to continue cutting interest rates, with UBS forecasting a cumulative 100 basis point cut at the Fed’s three remaining policy meetings in 2024.
While other central banks, including the Swiss National Bank, the Bank of England and the European Central Bank, are also expected to cut rates, their approach is likely to be more measured.
A slower pace of cuts abroad could make the dollar less attractive relative to other currencies.
In addition to the interest rate outlook, concerns about the U.S. fiscal deficit are likely to further undermine confidence in the dollar. The Congressional Budget Office forecasts that interest costs on U.S. debt will outpace defense spending this year, underscoring the growing fiscal challenges facing the country.
As the U.S. presidential race heats up and Vice President Kamala Harris leads in polls, the budget deficit is likely to become a topic of debate, which could create additional headwinds for the dollar.
Global monetary policy developments are also challenging the US dollar. For example, the Reserve Bank of Australia is expected to maintain its current policy stance into next year, which could escalate pressure on the greenback.
Meanwhile, the Swiss franc should remain sturdy due to its safe-haven status and the expected end of the Swiss National Bank’s monetary easing cycle in September.
UBS forecasts that by June 2025, the euro, the British pound and the Australian dollar will strengthen against the US dollar, reaching 1.16, 1.38 and 0.70 respectively.
The expected weakening of the US dollar has significant implications for global markets. As the dollar falls, risk assets such as high-quality stocks are likely to become more attractive, especially in an environment where the Federal Reserve is cutting interest rates.
UBS suggests investors consider investing in high-quality bonds, especially those issued by investment-grade companies, to benefit from the changing economic environment.
Despite some signs of weakness in the U.S. labor market, such as a rise in unemployment in July, the overall picture remains resilient. Weekly jobless claims fell and consumer spending continued to show strength, easing fears of an immediate recession.
UBS maintains its forecast of a cushioned landing for the US economy, supported by expected Fed interest rate cuts.
