(Bloomberg) -- The dollar is poised to rally, as traders are overestimating the extent of Federal Reserve rate cuts and underestimating a retail sales report coming on Tuesday, said Skylar Montgomery Koning, a foreign-exchange strategist at Barclays.
She predicts that stronger-than-expected retail sales will shift market bets toward a smaller rate reduction, and therefore boost the dollar. With only two days before the rate announcement, traders’ uncertainty about the decision is the highest since 2007 and this consumer report is one of the last pieces of information ahead of it.
“We expect a stronger-than-consensus number and last month the retail sales numbers were very strong as well,” Montgomery Koning said in an interview. “You could have the pricing shift more toward 25 basis-point cut.”
The Bloomberg Dollar Spot Index may rally 1% on that news, and much of the gain will come from the euro side, she forecast.
Markets have been balancing between a quarter-percentage point rate reduction and a cut twice that size, often reacting to new economic data. Investors are also expecting Fed Chair Jerome Powell to offer guidance on Wednesday when making the rate announcement, and for the Fed to update its economic projections.
The dollar index fell as much as 0.4% Monday, touching the lowest level since January. The euro gained about 0.4% on the day, with the British pound outperforming peers among developed economies and rising 0.6%.
Barclays forecasts three 25 basis-point reductions this year as the economy is still strong.
Economists are generally projecting retail sales to have declined last month in the back of weaker auto sales. If sustained, that would support the narrative that the recent slowdown in the labor market would translate into more cautious consumers.
However, markets are prone to overreact when it comes to rate-cut expectations, Montgomery Koning said.
“Most of the time in those soft-lending periods, if you look at the historic ones, the market consistently overestimates the amount of Fed cuts,” she said. “And when you get that turning point in expectations, that’s when you get the dollar rally.”
--With assistance from Augusta Saraiva.
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