Fed's stringent policy to delay rate cuts till 2025, strengthening dollar

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Fed's stringent policy to delay rate cuts till 2025, strengthening dollar

The Federal Reserve's strict monetary policy aimed at battling persistent inflation is projected to postpone rate cuts till 2025, thereby bolstering the dollar in 2024, according to a recent analysis by Nordea. This policy decision is anticipated to strengthen the EUR/USD to 1.15 by the end of 2025, keep GBP/USD below 1.25 throughout the forecast period, and elevate AUD/USD forecasts to 0.75 by the end of 2025.

Nordea's exchange rate forecasts underscore the difficulty of lowering interest rates across major economies due to actual inflation, a scenario not seen since the 1980s. The US economy's lower debt levels and more accommodating fiscal policy make it less susceptible to higher interest rates. Nordea predicts increased pressure on yields due to a high supply of Treasuries, creating a volatile environment for bonds and possibly leading the 10-year rates to revisit the 5% mark soon due to a FOMO-driven bond rally.

Despite a weaker economy, Nordea expects it will take significantly longer for the European Central Bank (ECB) to be convinced that inflation will sustainably reach the 2% target. A first interest rate cut is seen as feasible in June 2024 with gradual rate cuts to around 2.25% by end-2025. Despite higher yields potentially supporting the dollar, Nordea suggests that the continuation of the US's solid economic out-performance is unlikely.

If European economies can cut interest rates in summer 2024, confidence in the economic outlook would improve. However, significant dollar gains are unlikely with net losses into 2025 due to various risks including US government debt troubles, the US Presidential election, and geopolitical challenges.

In the long term, Nordea expects risk conditions to improve, supporting EUR/USD and risk-sensitive currencies like Norwegian and Swedish currencies. However, patience will be required to control inflation and delay gains in risk-related assets. The Euro to Pound forecasts have been slightly adjusted, and the Australian, New Zealand, and Canadian dollars are all forecast to make headway in 2024 and 2025, indicating net long-term recoveries.

The Federal Reserve and other central banks are engaged in a protracted battle against inflation, Nordea researchers suggest, with no anticipated rate cuts until 2025 due to a high bar set for cuts - a lesson from 70s easing errors. The reduced vulnerability of the real economy to rate hikes highlights the importance of indirect impacts from financial conditions. Analytical tools such as the Taylor Rule suggest an overly relaxed policy stance even at 5.5%. Amid caution about further rate hikes, the Fed may require all of next year to assess whether their policy is over-tightened or if a loosening is warranted.

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