Dollar will be cut down to size if Fed gives in to market whims - Reuters poll

By Hari Kishan and Rahul Karunakar

BENGALURU (Reuters) - The U.S. dollar's dominance will come to an end if the Federal Reserve gives in to pressure from financial markets and President Donald Trump and chops interest rates another 50 basis points this year, a Reuters poll of market strategists showed.

While a complete U-turn in expectations for Fed policy toward easing compared to tightening at the start of the year has not driven the dollar weaker, the latest poll of 60 analysts still showed a weaker outlook for the greenback.

The U.S. central bank delivered a rate cut last week but the dollar held firm, mostly driven by Fed Chair Jerome Powell's comments citing the latest move as "a mid-cycle adjustment to policy," dampening expectations for aggressive easing.

While the greenback's allure has remained intact on solid demand for dollar-denominated assets, over 40% of the strategists who answered a separate question said a change in Fed policy expectations would drive the currency from here.

Financial markets are pricing in at least two 25 basis point Fed rate cuts by year-end, according to CME Fed Watch. That would weaken the dollar significantly, according to the majority of responses to an additional question.

"The dollar needs to be knocked off its perch as one of the key high yielding G10 currencies. So if rates evolve the way the markets are discounting at the moment...that would probably go a long way in weakening the dollar," said Adam Cole, head of FX strategy at RBC.

While Powell's message is clear that this is not the start of an easing cycle the central bank has been pressured repeatedly by Trump, who has called out the Fed chief he appointed for not cutting rates more aggressively.

The Fed - which wants to assert its independence - is conflicted by economic data not yet supporting aggressive easing. At the same time, worries about spillover from the U.S.-China trade war warranted action at the end of July meeting, and has escalated sharply since then.

"We are seeing a Fed which is under extreme political pressure. Whilst Powell continues to push back against that in public, it is still a pretty invidious situation," said Jeremy Stretch, head of G10 FX strategy at CIBC.

"They (markets) would probably need to see the Fed being much more aggressive probably under the auspices of pressure from the White House in order to facilitate a cheaper dollar."

Many other central banks are also easing or at least hinting at doing so, and in some cases, as with the Reserve Bank of New Zealand on Wednesday, delivering bigger-than-expected moves.

That makes the argument on interest rate differentials invalid at least until the Fed follows through on expectations, according to Eric Theoret, currency strategist at Scotiabank. He argues currencies are being driven more by sentiment and risk aversion rather than economic fundamentals.

"As we move towards the actual delivery of those cuts we do expect the U.S. dollar to weaken. Market pricing is one thing but the actual delivery is obviously what is important," Theoret added.

Most major currencies have broadly underperformed against the dollar this year, contrary to what analysts have been predicting in Reuters polls.

The euro, which is down over 2% this year, is forecast to have gained 3% in 12 months to trade at $1.15. It was changing hands at $1.11 on Wednesday.

Analysts have been trimming their 12-month views for almost a year and the latest consensus is the lowest in two years.

The single currency is under pressure as the European Central Bank is expected to cut its already negative deposit rate next month and likely restart its asset purchases programme soon.

When asked how low could the euro go based on any potential ECB stimulus, forecasts ranged from as high as $1.15 to a single call for just below parity with the dollar.

"Can or does the ECB have the firepower to depress the euro valuation and also encourage imported inflation expectations materially higher? I'm not sure if it does," said CIBC's Stretch.

"If we are going to see a higher euro/dollar, then it is from the U.S. side of the equation than it is from the auspices of the ECB."

(Polling by Sarmista Sen and Nagamani Lingappa; Editing by Hugh Lawson)