The U.S. dollar’s recent recovery is beginning to wane, which encourages bears who predict that the currency will only see brief moments of growth in the months to come.
After last week’s shocking employment data, the dollar experienced a significant rebound against the major currencies, increasing the appeal of the dollar as a safe-haven currency as investors reassess their bets on how high the Federal Reserve will raise interest rates in order to contain inflation.
The ICE U.S. Dollar Index DXY, -0.66%, which compares the dollar to a basket of six important competitors, was down 0.7% at 102.71 on Thursday morning, on pace for a marginal loss.
After the rally halted a rise that sent the index to a 20-year high, investors began to question if a still-hawkish Fed could maintain the dollar and aid in its recovery of all the losses sustained over the previous four months. According to Dow Jones Market Data, the dollar index has dropped 8.7% since mid-October after rising for the most of 2022.
According to Steve Barrow, head of G-10 strategy at Standard Bank, the Fed’s commitment to squeezing inflation out of the economy won’t send the dollar soaring.
The dollar should depreciate as long as the market believes the Fed is at or near the peak of the rate cycle and may still see the possibility of rate reduction in 2019 according to a note from Barrow on Tuesday. However, this policy stance shouldn’t depress asset values such as stock prices.
He continued, “In our view, the risk of a meaningful and sustained dollar surge from monetary policy alone comes if the Fed proves to be behind the inflation curve again because labor market pressure, and possibly other factors, cause a re-acceleration of inflation that threatens multiple rate hikes.
The Fed may need to raise interest rates “marginally higher” than what the market expects, which might support the dollar, according to Barrow and his colleagues, but they don’t expect them to do so for very long.
According to the CME’s FedWatch tool, they also projected 25 basis points of rate reductions by the end of 2023.
Barrow and his team predict that the dollar will strengthen for “periods throughout the year,” possibly as a result of revised Fed rate expectations, but “these bumps in the road should not change the general direction in our view, which is for a weaker dollar in 2023,” and these “comebacks” won’t be powerful enough to inspire the dollar to test its 2022 highs.
Any additional strengthening of the dollar in the short future, according to Charalampos Pissouros, senior investment analyst at XM Investment, may be in jeopardy when more significant economic data is released the following week.
The headline and core CPI numbers are expected to show continued declines in the January inflation data, which is scheduled to be released on Tuesday. This could “revive speculation about a lower peak in U.S. interest rates as well as more rate cuts for later this year,” Pissouros wrote in a note on Wednesday.
The dollar may once again be sold off as a result of fresh pressure on Treasury rates, he continued.