Title: The Dollar’s Sudden Reversal — What’s Behind the Change?
Author: Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE, ING
Original Source: “The Dollar’s Handbrake Turn” – Published on Think.ing.com
Overview
The US dollar has recently undergone a pronounced shift in its trajectory, effectively making a sudden U-turn after months of steady strength. This surprising development follows soft US economic data and changing expectations around Federal Reserve policy. In this article, we explore the key factors behind the dollar’s decline, assess market reactions, and examine future prospects for the greenback.
Soft US Data Triggers Dollar Weakness
The most important catalyst behind the dollar’s recent decline has been unexpectedly weak US economic indicators, which have caused global investors to reassess the path of future Federal Reserve interest rate decisions.
– Recent US payroll figures came in below expectations, challenging the notion of an overheating labor market.
– The Institute for Supply Management (ISM) services index fell from 51.4 to 48.8 in June, moving into contractionary territory and raising concerns about broader economic momentum.
– Weekly jobless claims have shown an upward trend, suggesting that hiring may be slowing across key sectors.
These developments have called into question the assumption that the Fed would hold interest rates at elevated levels for an extended period. Markets are now increasingly pricing in an earlier start to interest rate cuts, with many participants predicting the first move could come as early as September.
Shift in Fed Rate Expectations
Prior to the recent run of data, market participants had largely aligned with the Fed’s own projections, which suggested just one interest rate cut before the end of 2024. However, the narrative shifted quickly.
– Fed Funds futures are now pricing in almost two full cuts by December.
– Some market players believe there is even a non-negligible chance of a third cut if further data shows slowing inflation and economic activity.
This pivot in expectations has weakened appetite for holding US dollars from a carry-trade perspective. As the gap between US and foreign interest rates narrows, the incentive to park money in dollar-denominated assets decreases, leading to reduced dollar demand.
Comparing Dollar Performance Across Major Currencies
The greenback’s about-face has been felt most prominently against a basket of major currencies. Here’s how the recent dollar slide compares across several currency pairs.
EUR/USD:
– The euro has reclaimed key levels and now trades comfortably above 1.08.
– Soft US data suggests EUR/USD may continue toward the 1.10 mark, particularly if eurozone data stabilizes and tensions in France ease following recent elections.
USD/JPY:
– The yen has surged as US Treasury yields fell in line with lowered Fed expectations.
– Japanese authorities remain wary of yen weakness and may now find market dynamics more favorable for avoiding further depreciation.
– If US yields keep falling, USD/JPY could drop below 155 in the coming weeks.
GBP/USD:
– The British pound has recovered lost ground, trading close to 1.28.
– The UK election outcome, which delivered a Labour majority under Keir Starmer, has been largely market-neutral.
– Bank of England policy positioning remains slightly hawkish compared to the Fed, providing underlying support for sterling.
AUD/USD and NZD/USD:
– Both antipodean currencies have benefitted from the broader dollar weakness.
– The Reserve Bank of Australia and the Reserve Bank of New Zealand remain relatively hawkish, particularly with domestic inflation still above target.
– AUD/USD could push toward 0.68, while NZD/USD heads toward 0.62 if risk appetite holds up.
CNY and Emerging Markets:
– China’s renminbi has held relatively stable amid stronger central bank guidance.
– Emerging Market (EM) currencies have generally firmed, buoyed by greater risk appetite and increased carry opportunities as US yields decline.
Treasury Yields Fall: Another Pressure Point
Parallel to the dollar’s retreat, US
Explore this further here: USD/JPY trading.