Time has come to buy dollar, BCA says, ahead of Fed rate-cutting cycle

Investing.com -- The dollar snapped its four-week losing streak on Friday, and some believe the time has come to buy the greenback as this fighting spirit is set to continue.

"We have been recommending a trading range in the DXY between the 101 and 108 level. The DXY recently hit our buy zone, and we suggest it is time for investors to be long," BCA Research said in a recent note.

The bullish outlook on the dollar has history, or rate-cut cycle history on its side, BCA notes, adding that the ebbs and flows in the FX market during a rate cutting cycle is fairly consistent.

The dollar has tended to be flat-to-down in most cycles leading to the first rate cut by the Federal Reserve. But the dollar is now already at its lowest point compared to previous cycles, assuming the Federal Reserve begins interest-rate cuts in September, suggesting the room for significant downside could be limited.

"The median rally in the DXY over the ensuing 12 months after the Fed eases policy is 5%," BCA added.

In prior cutting cycles, the Fed has cut interest rates by close to 400 basis points on average over the 12 months following the start of an easing cycle. This time, however, the market is pricing in Fed rate cuts of about 200 basis points, or half of the historical average.

"If our thesis is correct and the Fed does not cut rates by more than what is already priced in markets, this bodes well for the dollar," BCA said.

The divergence in monetary policy expectations between the U.S. 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 the UK and the Euro Area. 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 prolonged rally.

Sentiment toward the dollar is already bullish, BCA says, as "most investors are already long the dollar," running the risk of a catalyst forcing 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, flagging a volatility as a key measure to watch given its close correlation with the dollar.

"Among the measures we care about the most, we will be tracking trends in volatility," it added.

This article first appeared in Investing.com