LIVE MARKETS-What's in store for the dollar once the Fed starts cutting?

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WHAT'S IN STORE FOR THE DOLLAR ONCE THE FED STARTS CUTTING?

Just ahead of the Federal Reserve's widely expected to kick-off an interest rate cutting cycle on Wednesday afternoon, Calvin Tse at BNP Paribas was out with a note looking at the possible direction of the U.S. dollar as a result of the easing.

According to Tse, the bank's head of U.S. strategy and economics, if the Fed cuts and there is no subsequent recession then, historically, the dollar "tends to benefit from inflows into U.S. equities."

While he writes that the pattern "seems unlikely to hold true here," the market's awareness of historical trends may lead to some closing out of shorts in the near-term, Tse said.

BNP looked at the last 8 easing cycle kick-offs and separated out those that came with a recession in the following year and those that weren't followed by a recession. They found that the dollar tends to rally by 4.75%, on average, in the next six months if there's no recession. If there's is a recession, it will trade flat, according to Tse.

In its sample, the SPX rallied 10.7% in the six months after the first cut if there was no recession but sold off 2% when there was a recession. And USD returns "very closely match SPX returns in the former case."

"In contrast, if a recession eventually materializes, generally the USD tends to soften initially but then rebound once equities decline sharply, " Tse wrote.

But given past patterns they do see the risk of a squeeze in what they perceive as "entrenched USD shorts" after the first Fed cut.

If the US economy goes into a recession, BNP says "it’s unclear that the USD would perform as well on risk-off sentiment as in the past." They point to April’s risk-off market, where the dollar trailed.

"We think this is because the correlation between the USD and US equities remains positive, indicating that the currency now trades more in line with risky assets," Tse said.

(Sinéad Carew)

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