Dollar Weakens as Bets on Fed Rate Cuts Drive Markets
The dollar experienced a broad decline on Thursday, with the Japanese yen, euro, and pound reaching their strongest levels against the U.S. currency in five months. This comes as markets anticipate that the Federal Reserve will implement significant rate cuts in 2024 to avoid a recession. The dollar index, which measures the U.S. currency against six rivals, dropped to a fresh five-month low of 100.61. This year, the index is expected to decline by 2.7 percent, breaking its streak of strong gains over the past two years.
According to Nick Rees, an FX analyst at Monex Europe, “With little news to trade over the holidays, markets have just continued doing what they were doing previously—taking Treasury yields lower, equities higher—and in effect pricing the kindest of soft landings that has consequently seen the dollar continue to sell-off.”
The Japanese yen was the most significant mover of the day, with the dollar falling as much as 0.82 percent to 140.66 yen, its lowest level since July. The yen is particularly sensitive to changes in U.S. rates, and the yield on the benchmark 10-year U.S. Treasury dropped nearly 10 basis points on Wednesday to its lowest point since July.
However, despite earlier movements this year, the dollar is still up over 7 percent against the yen in 2023. Bank of Japan Governor Kazuo Ueda stated that he is not in a rush to unwind ultra-loose monetary policy due to the small risk of inflation running well above 2 percent and accelerating.
Markets are currently pricing in an 88 percent chance of a U.S. rate cut in March 2024, according to the CME FedWatch tool. Futures imply more than 150 basis points of Fed easing next year, although there may be some bumps along the way. Mr. Rees commented, “Markets are now looking for more than six full rate cuts from the Fed and no U.S. recession, which seems optimistic to us. Though we could ultimately end up there, it would be very surprising if we did not see at least some hiccups in the process that aren’t currently priced in, something which should see the dollar snap back when markets pick up again in January.”
While the Federal Reserve has taken a dovish stance in its December meeting, opening the door to rate cuts next year, other major central banks, such as the European Central Bank, have maintained their position of needing to keep rates higher for a longer period. However, markets are still pricing in as much as 165 basis points of rate cuts from the ECB in 2024.
The euro strengthened by 0.15 percent to $1.121, reaching a five-month peak of $1.11395 earlier in the session. The single currency is expected to have a yearly gain of 3.7 percent, its strongest performance since 2020. Sterling also rose to $1.2825, its highest level since August. The pound is on track for a nearly 6 percent gain this year, its biggest increase since 2017.
The Swiss franc also firmed to 0.8339 per dollar, its strongest level since January 2015 when the Swiss National Bank discontinued its policy of maintaining a minimum exchange rate against the euro.
The weakness of the dollar has also led to gains in emerging market currencies. MSCI’s emerging market currency index reached a 20-month high and is expected to have its strongest year since 2017 with a 5 percent gain.
By Ankur Banerjee and Alun John
