Investing.com — The index snapped its four-week losing streak on Friday, and some believe the time has come to buy the dollar as this belligerence will continue.
“We have recommended a trading range in the DXY between the 101 and 108 levels. The DXY recently reached our buy zone and we suggest it is time for investors to go long,” BCA Research said in a recent note.
The bullish outlook for the dollar has history, or the cycle of rate cuts, on its side, BCA notes, adding that the ebb and flow in the currency market during a rate cut cycle is fairly consistent.
The dollar has tended to flatten down in most cycles, leading to the first rate cut by the Federal Reserve. But the dollar is already at its lowest point compared to previous cycles, assuming the Federal Reserve starts cutting rates in September, suggesting that room for significant downside could be limited.
“The average rally in the DXY over the subsequent twelve months after the Fed eases policy is 5%,” BCA added.
In previous rate-cutting cycles, the Fed has cut rates by an average of nearly 400 basis points over the 12 months following the start of an easing cycle. This time, however, the market is pricing in Fed rate cuts of around 200 basis points, or half the historical average.
“If our thesis is correct and the Fed does not cut rates more than what is already priced in the markets, this bodes well for the dollar,” BCA said.
The divergence in monetary policy expectations between the US and other major economies is also expected to support the dollar.
“Our work (on the sensitivity of GDP to interest rates) suggests that policy is already very restrictive for Britain and the eurozone. These economies are thus likely to witness a deeper recession relative to the US,” BCA said.
But not everyone is convinced that the dollar’s recent strength marks the start of a long-term rally.
Sentiment toward the dollar is already bullish, BCA says, because “most investors are already long the dollar,” which risks creating a catalyst that forces potential leveraged liquidation in long dollar positions.
“This catalyst will come in the form of higher stock prices, lower bond yields and low volatility,” BCA said, citing volatility as a key metric given its close correlation with the dollar.
“One of the measures that interest us most is monitoring trends in volatility,” it added.
