Synopsis:

SocGen explores the historical impact of Fed easing cycles on the US dollar over the past 40 years, highlighting varying reactions and suggesting that the current economic context might lead to modest dollar weakness in the year ahead.

Key Points:

1. Historical Reactions to Fed Easing:

   • 1985: The dollar fell significantly but only four months after the first rate cut.
   • 1989: The dollar started falling within days of the first cut but rallied between the first and third cuts in 1996/96.
   • 1998: The dollar fell before the Fed cut rates due to the collapse of LTCM.
   • 2000-2004: The dollar was falling when the Fed started to ease in 2000, bounced in 2001, and fell sharply from 2002 to 2004 as rates continued to decline.
   • 2004-2007: The dollar mostly fell as rates rose in 2004, bounced in 2005, but was falling again before the Fed started easing in 2007.
   • 2019-2020: During the easing cycle starting in July 2019, the dollar fell for a few months and continued falling as COVID-19 emerged, leading to significant Fed easing and a substantial dollar fall in 2020.

2. Protracted vs. Brief Easing Cycles:

   • A protracted Fed easing cycle is likely to weaken the dollar significantly.
   • A brief easing cycle might not trigger much of a reaction, as seen in 1996 and 2019, where money flows into US assets mitigated the dollar's decline.

3. Current Dollar Context:

   • The current dollar peak is the highest in real terms since 1984/85, narrowly exceeding the 2002 peak.
   • Both historical peaks saw delayed but substantial dollar falls, accompanied by significant Fed easing cycles.
   • The size of the current positioning and the dollar’s high level suggest potential for a big move.

4. SocGen’s Forecast:

   • SocGen anticipates modest dollar weakness in the year ahead, projecting a fall of less than 5%.
   • This forecast leaves the dollar 10% stronger than at the start of 2021, 3% stronger than at the start of 2020, and 25% stronger than when it began its ascent in 2014.

Conclusion:

While historical patterns indicate varied reactions to Fed easing cycles, SocGen predicts modest dollar weakness in the upcoming year. This outlook factors in the current high level of the dollar and significant positioning, along with the potential for a protracted Fed easing cycle, which could lead to a more pronounced decline.