With the Fed's recent 50-basis-point rate cut in the books, Bank of America analysts addressed client concerns regarding the potential impact on the U.S. dollar (USD) and historical parallels.
Unfortunately, there are no perfect analogs to the current economic environment, according to the bank.
Analysts explain that while the economic conditions are somewhat similar to 1995, during which the USD was undervalued, today the USD is overvalued, making comparisons difficult.
After the Fed's cut, the USD experienced a full round trip—initially depreciating but then rebounding after a lack of dovish tone from Fed Chair Jerome Powell during the press conference.
His optimistic view on the economic outlook and the policy path, alongside his characterization of the 50-bps cut as a "recalibration," helped to stabilize the dollar.
BofA says that historically, the USD's performance during past cutting cycles has been mixed.
The bank highlights that the dollar has rarely rallied during easing cycles, except in 1995 when it was undervalued. However, this time the USD is more likely to gradually depreciate from its broadly overvalued levels, though not necessarily in a straight line.
Analysts pointed out that the Fed's focus has shifted to the employment side of its mandate, and further rate cuts could become more likely if labor market data weakens.
A faster decline in the USD would also depend on improved economic conditions abroad, but for now, the main factors impacting the dollar remain U.S. rates and risk appetite tied to U.S.-centric economic data, according to BofA.
As the easing cycle progresses, the bank states: "A concerted Fed easing cycle still has scope to see hedge funds further reduce USD longs, and/or real money to re-establish short positions."
However, analysts believe the USD's path will likely be influenced by a combination of U.S. economic data and global growth conditions.