Is the dollar rebound hard to sustain? Citigroup: This week's Federal Reserve decision cannot reverse expectations, non-farm payrolls are the key

The recent rebound of the US dollar has attracted market attention. The Federal Reserve's interest rate decision on Wednesday may lay the groundwork for a rate cut in September, putting pressure on the dollar, but the key factor driving the next round of movement will still be Friday's non-farm payroll data.

According to Chase Trading Desk, Citigroup analysts pointed out in their latest research report that if signs of weakness appear in the US labor market, it will trigger a reassessment of more dovish expectations for the Federal Reserve, thereby driving a new round of decline in the dollar. Citigroup expects non-farm payroll growth in July to slow to 100,000, with the unemployment rate possibly rising to 4.2%.

Regarding the Federal Reserve meeting on Wednesday, Citigroup does not expect it to be a major market catalyst, as the market has already priced in expectations for a rate cut in September. The real focus will be on Friday's non-farm payroll data, which will be the decisive factor for the dollar's movement.

Citigroup emphasized that the market's bearish stance on the dollar still holds appeal, despite the European Central Bank's hawkish stance having weakened its support for the euro.

Behind the Dollar Rebound: Weakening Hawkish Effect of the ECB

In the past week, the dollar has shown a significant rebound, mainly reflecting the combined effects of two factors. Citigroup analysts pointed out that, on one hand, the European Central Bank's hawkish stance, which has supported the euro's rise, is weakening; on the other hand, leveraged funds have been buying dollars since the last non-farm payroll data was released.

Data shows that despite ECB President Lagarde sending hawkish signals and the market repricing the ECB's policy expectations, the euro has failed to rise against the dollar. This indicates that the ECB's policy is losing its driving force for the euro, while the dollar has gained rebound momentum from this.

Citigroup also observed signs of position squeeze in the recent market, where currencies that performed well previously have generally underperformed in recent trading. This adjustment based on market positions has intensified the short-term rebound of the dollar.

For the Dollar, the Importance of the Fed Decision is Secondary to Non-Farm Data

The Federal Reserve's monetary policy meeting on Wednesday is not expected to bring significant surprises, as the market has already priced in a 16 basis point rate cut for September. Citigroup emphasized that without new inflation or labor market data to support it, Fed Chairman Powell may remain cautious, leaving room to convey signals for a September rate cut through subsequent monetary policy meeting minutes or the Jackson Hole meeting.

Analysts wrote: “We must remember last summer's situation— the Fed kept rates unchanged in July but then received weak labor market data and cut rates by 50 basis points in September 2024.”

Citigroup believes that the real market catalyst will be Friday's non-farm payroll report. Citigroup economists expect employment growth to slow significantly to 100,000, with the unemployment rate rising to 4.2%, which may create conditions for further weakness in the dollar.

Is the Dollar Facing a New Round of Decline?

Citigroup maintains its bearish stance on the dollar, expecting that softening U.S. labor market data will drive further expectations for interest rate cuts by the Federal Reserve, leading to a new round of declines for the dollar. Analysts particularly point out that Challenger layoff announcements, as a leading indicator, suggest potential short-term weakness in the labor market.

“For dollar bears, the risk/reward ratio remains attractive,” the Citigroup report states, emphasizing the market's asymmetric reaction to a weaker dollar—namely, that poor U.S. employment data could lead to a more significant decline in the dollar, while strong employment data would have limited positive effects on the dollar.

Overall, Citigroup believes that the current market positioning makes the euro against the dollar still attractive for bulls, even in the face of short-term volatility, as the long-term trend points towards a weaker dollar, especially if labor market data confirms that the economic slowdown is accelerating.