Dollar Bear Market Outlook: A Comprehensive Assessment and Analysis

After experiencing record declines earlier this year, the US dollar has recently stabilized, but most foreign exchange market participants still believe it is in a bear market trend and will face further depreciation. In the six months ending in June, the Dollar Index fell by approximately 11%, marking one of its largest historical declines. While the dollar exchange rate has recently stabilized due to a sharp pullback in bearish futures positions, data from the U.S. Commodity Futures Trading Commission (CFTC) shows that as of last week, speculators' net short positions on the dollar were $5.7 billion, a significant decrease from $21 billion at the end of June, but still historically high.

Why Does the Dollar Remain Under Pressure?

Most investors believe that the dollar sell-off is just a temporary pause and not a trend reversal, and the core market concerns include: persistent high US fiscal and trade deficits, the potential for a weak labor market to prompt the Federal Reserve to cut interest rates more aggressively, and global fund managers reassessing foreign exchange hedging strategies to reduce their dollar exposure. "The dollar is in the process of declining, and that decline is not over yet," says Francesca Fornasari, head of currency solutions at Insight Investment. "This process will be messy, and it is likely to be accompanied by a lot of volatility." Many of the factors that previously drove the dollar down remain in place, including: a re-examination of "American exceptionalism," concerns about slowing economic growth due to President Trump's trade protectionist stance, and continued worry about the twin deficits problem.

Impact of Employment Data and Fed Policy

A series of weak employment data provides the Federal Reserve with room to cut interest rates more aggressively, which will weaken the dollar's interest rate advantage. "The market is now starting to think: how weak is the U.S. economy going to be... how low is the labor market going to go in the future? What does that mean for Fed monetary policy?" says Paresh Upadhyaya, head of fixed income and currency strategy at Amundi, Europe's largest asset management company. The Federal Reserve is likely to resume cutting short-term interest rates next week and cut interest rates consecutively during the remainder of this year. Upadhyaya, who had a bearish stance on the dollar at the beginning of the year and has been increasing short positions on the dollar, says there is currently no reason to change this strategy.

Hedging Challenges Faced by Global Investors

Industry insiders point out that the superior performance of US assets for many years has led to excessive exposure of global investors to US assets. The tariff fluctuations in April prompted some investors to reduce their positions and reassess hedging strategies, but this position adjustment is far from complete. Data from institutions such as Deutsche Bank shows that foreigners hold trillions of dollars of US assets, and any reduction in exposure could put pressure on the dollar, but this pressure has not yet manifested on a large scale. "If foreign investors decide to start reducing their allocation to U.S. assets, the dollar may see another round of sharp declines," says Upadhyaya of Amundi. The weak performance of the dollar in the first half of the year has led asset management companies to increase hedging operations. Fornasari of Insight Investment says that market participants who react slowly may join this camp in the next three to six months. Hedging transactions typically involve selling dollars through forward contracts or swap instruments, which increases the supply of dollars, thereby putting pressure on the dollar exchange rate. As the Federal Reserve cuts interest rates, the relatively lower US interest rates compared to overseas will also reduce the cost of mainstream hedging instruments, enhancing the attractiveness of foreign exchange hedging. "Clearly, further interest rate cuts from the Federal Reserve from current levels will enhance the incentive for foreign investors to hedge dollar assets," said George Saravelos, global head of foreign exchange research at Deutsche Bank, in a report on Monday.

Trump Administration Unlikely to Support the Dollar

Industry insiders also expect that dollar bulls are unlikely to receive support from the Trump administration, because the "America First" agenda and the plan to revitalize American manufacturing are at odds with the goal of a strong dollar. However, the Trump administration occasionally expresses its commitment to maintaining the dollar's strength and influence. "They still believe in 'strong dollar' and 'dollar hegemony', but they hope the dollar will be slightly weaker than its high levels at the beginning of the year," says Thanos Bardas, managing director and co-head of global investment-grade fixed income at Neuberger Berman. "If the Dollar Index remains at 110, there is absolutely no possibility of manufacturing returning to the United States," Bardas says. He expects the Dollar Index to fluctuate between 95 and 100 in the short term. "I don't think the U.S. will explicitly send a signal that it 'wants the dollar to weaken', but it will not hinder the dollar from weakening," says Shaun Osborne, chief foreign exchange strategist at Scotiabank. Osborne expects the dollar to fall another 5% to 7% against major currencies in the next year or so.

Most Experts Still Believe the Dollar is Overvalued

Considering that the dollar has fallen a lot this year, and the market has absorbed expectations of significant easing by the Federal Reserve, there is still a possibility that the dollar will receive support. Bardas of Neuberger Berman says that one risk facing the bearish view on the dollar is: an unexpectedly improved outlook for US economic growth. Driven by corporate investment in areas such as artificial intelligence and intellectual property rights, US economic growth in the second quarter was revised upward from initial estimates, but import tariffs still make the economic outlook uncertain. However, industry insiders say that relative to many currencies, the dollar is still overvalued, which deters potential buyers in the foreign exchange market. It is well known that the foreign exchange market is characterized by the fact that currencies often overcorrect in the long term in both directions. "The dollar is now only approaching what I consider to be the 'neutral valuation level'," says Upadhyaya of Amundi, noting that the dollar has not yet reached the point of being undervalued. "There is still more movement in the dollar bear market waiting to happen," he says.