Investing.com -- As the global economy grapples with uncertainties, the United States appears to be on track to achieve a "soft landing," a scenario where the economy slows down without entering a recession.
This potential outcome, as per analysts at Goldman Sachs (NYSE:GS), aligns with a weakening US dollar. “Despite recent market turbulence, the US economy looks close to achieving a soft landing, with the Fed likely to deliver the first non-recessionary cut in September,” the analysts said.
The expectation is that this policy move will help the economy stabilize without tipping into a full-blown recession.
The term "soft landing" refers to a situation where economic growth slows enough to curb inflation but not to the extent that it triggers a recession.
Historically, achieving such an outcome has been challenging, but the current economic indicators suggest that the US might be able to navigate this delicate balance.
The analysts at Goldman Sachs flag a unique development in the current economic environment: the recent recovery in risk sentiment has been accompanied by dollar weakness, rather than strength, as seen in previous periods of strong US equity performance. This shift has added momentum to the "soft landing, weaker dollar" trade.
Several factors contribute to this scenario. The Fed's potential rate cuts are a significant driver, as they can adjust real rates faster than other central banks facing downside risks to growth.
When these rate cuts are perceived as part of policy normalization rather than a response to a recession, they tend to support equity markets. In turn, this equity upside, coupled with improving global growth expectations and positive risk sentiment, typically exerts downward pressure on the dollar.
Goldman Sachs' further indicates that the dollar's relationship with US growth is more relative than absolute.
The dollar does not consistently strengthen when US growth is robust, nor does it always weaken during periods of weak growth. Instead, the dollar's performance is closely tied to how US growth compares to growth in other major economies.
For instance, when US growth is negative while the rest of the world experiences positive growth, the dollar tends to weaken. This relationship underscores the importance of considering global economic conditions when assessing the dollar's trajectory in response to US economic data.
“Especially now, we would caution that the sensitivity of the broad Dollar to relative equity performance is at least as high as that to relative rates this year,” the analysts said. When US equities are driving global equity outperformance, the dollar tends to strengthen.
However, in the current environment, where the Fed is expected to ease monetary policy while US equities remain strong, this dynamic could limit the extent of the dollar's decline.
The dollar's current valuation is partly a reflection of the superior returns offered by US assets over an extended period.
This has attracted significant foreign investment, with nearly 30% of cross-border assets now allocated to the US. Such demand has supported the dollar's high valuation, making it less susceptible to rapid depreciation.
However, as the US approaches a potential soft landing, the combination of easing monetary policy and strong equity markets may create conditions for a gradual weakening of the dollar.
Goldman Sachs analysts caution that while the dollar may face downward pressure, the process is likely to be gradual, with the dollar's rich valuation providing a buffer against rapid declines.