Dollar drops to 20-year high as US inflation declines

Dollar drops to 20-year high as US inflation declines

The dollar has tumbled in the past fortnight from a 20-year high amid signs of slowing inflation in US fuel speculation that the Federal Reserve will soon slow its rate hikes.

The greenback has fallen more than 4% against a basket of six peers so far in November, leaving it on course for the biggest monthly decline since September 2010, according to Refinitiv data. It’s still up about 11% for the year to date.

This month’s fall comes as investors scrutinize early indications that U.S. inflation may finally be easing, which could pave the way for the Fed to reduce the rate at which it has been raising investment costs. loan. Some data, such as those on the housing and manufacturing sectors, also suggested that the economy as a whole is facing increasing headwinds, another deterrent to Fed monetary tightening.

“Everything points to disinflation in the United States and with that, we will see a slowdown in the American economy in the first quarter of next year . . . That forms the basis of the weaker dollar story, ”said Thierry Wizman, strategist at Macquarie.

The falling dollar has eased some of the pressure on a global economy that was creaking under pressure from a strong dollar, which is helping to drive up inflation in smaller economies and worsening debt sustainability issues for countries and companies – especially in emerging markets – that have borrowed heavily in US currency.

Line chart of the dollar index showing the US dollar falling from its highest level in 20 years

The euro climbed to nearly $1.04 after falling below 96 cents in September, and the pound’s recovery from an all-time low in September has accelerated further. The yen rebounded somewhat from a slide to a 32-year low against the dollar that had prompted the Japanese government to spend billions to prop up its currency.

Still, much depends on how the Fed reacts to data showing U.S. consumer and producer prices rose at a slower annual rate in October than September — and whether that trend continues. continues. At the central bank’s November meeting, Chairman Jay Powell did not explicitly signal a fifth consecutive 0.75 percentage point increase, which traders took as a sign of the Fed’s openness to an increase of half a percentage point from next month.

Indications of lower inflation also upset popular bets in the currency markets on a stronger dollar.

“We expect the US dollar’s powerful rise over the past year to reverse in 2023 with the end of the Fed’s hike cycle,” HSBC currency strategists wrote in a note to clients. this week. “It peaked.”

In recent weeks, traders have cut bets on a stronger dollar to the lowest level in a year, according to figures from the Commodity Futures Trading Commission, which provide insight into how speculative investors such as hedge funds are positioned on the foreign exchange markets.

The greenback’s historic ascent earlier this year came as a wave of rapid price increases swept the world, prompting major central banks – with the notable exception of the Bank of Japan – to quickly tighten their monetary policy. But rate hikes elsewhere have largely been unable to keep pace with the Fed, which, thanks to the relatively robust US economy, has been able to raise borrowing costs faster than its peers in other economies. developed, increasing the attractiveness of the dollar.

At the same time, fears of a global recession and financial market volatility triggered by rapid monetary tightening also favored the US currency, which, as the ultimate refuge of the global financial system, tends to appreciate in tense period.

Both of these tailwinds are now about to fade, according to HSBC, which argued that “gravity should set in” for the dollar as the often chaotic selling in global bond markets, caused in part by the rising central bank rates, calms down.

Despite the market turnaround, some hawkish rhetoric from Fed officials in recent days has tempered bets on the Fed’s slowdown.

The drop “looks like an overreaction given that Fed speakers have so far made it clear that the job is not done,” said Athanasios Vamvakidis, head of G10 currency strategy at Bank of America. .

Although the dollar may not surpass the 20-year high it hit in late September, Vamvakidis warned that inflation remains high. “We are not out of the woods yet. . . Even though inflation has peaked, it will be sticky and volatile on the downside.

With traders firmly focused on the monthly U.S. inflation numbers, a slight upside surprise could easily tip the entire global currency market the other way, he added.

That sentiment was evident in remarks by St. Louis Fed President James Bullard on Thursday, who said rates should be raised to a minimum of 5% to keep inflation under control.

Futures market positions currently reflect the fact that investors are seeing interest rates peak at 5% in May.

“It’s premature to call a dollar peak as the Fed expects further rate hikes,” said Convera analyst Joe Manimbo.

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