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According to Swiss private bank Lombard Odier, the outlook for the U.S. dollar is increasingly negative, with multiple macro and market factors aligned against it.
"We see further weakness ahead and have shifted our view on the currency from neutral to negative," says a new research note from Lombard Odier's Chief Investment Officer's office.
The downgrade is prompted by expectations for both domestic and global dynamics:
Federal Reserve Policy Expectations
“Market consensus is moving closer to our expectation for three interest rate cuts from the Federal Reserve before the year-end.”
This anticipated policy easing reduces the dollar’s interest rate advantage, making it less attractive for investors.
Term Premium & Fiscal Worries
"We expect the term premium to remain high in light of U.S. fiscal deficit widening."
A persistently high term premium (extra yield demanded by investors for holding long-term debt) alongside expanding deficits is seen as a negative for dollar demand.
Relative Yield Deterioration
"Relative yield developments will therefore be detrimental to the USD."
As other central banks keep rates stable or only modestly reduce them (especially in emerging markets), the yield spread advantage shifts away from the US.
Lower Hedging Costs & Positioning
"Falling hedging costs associated with lower US policy rates and less extreme short investor positioning" are also undermining dollar support.
Geopolitical and Trade Policy Tailwinds for EM and Their FX
A '90-day truce' between the U.S. and China and more measured tariff applications have reduced EM currency volatility.
No major retaliation to the U.S. tariffs from emerging markets limits inflation and supports FX stability.
The CIO team has increased exposure to emerging market hard currency bonds and EM equities, betting on sustained dollar weakness.
They highlight that EM assets are under-owned and undervalued, setting up a reallocation trade if the dollar declines.
"A depreciating dollar (and appreciating EM currencies) has generally coincided with EM equity inflows and positive equity performance," say analysts.