Macroscope | US dollar bulls could be skating on thin ice
- Recent speculation that the Federal Reserve will raise interest rates significantly this year has boosted US dollar sentiment
- However, with the jury still out on economy recovery and the Fed less likely to go for overkill on inflation, it won’t be too long before interest rate expectations level off
Don’t get your hopes up that the US dollar is enjoying a sea-change in fortunes. In fact, there is every chance dollar bulls are skating on thin ice after recent speculation that the US Federal Reserve is adopting a tougher guard against inflation.
The Fed seems set to take the key funds rate to a peak between 5 to 5.25 per cent in the next few months, but there’s still scope to ease policy before the end of the year to give the US economy a boost as the Fed’s focus switches from inflation to growth.
It’s true that there has been some modest realignment in US interest rate perceptions in recent weeks as the economy has performed better than expected. US inflation fears have eased considerably and the economy is in a better place, but the Fed’s attention may now be focused on stronger-than-expected domestic demand, leaving little scope for the central bank to soften on its apparent commitment to toughen up policy.
As inflation pressures progressively eased, US money market futures had taken a more dovish view of Fed policy intentions, looking for the funds rate to peak at 5 per cent in the next few months but with the possibility of lower interest rates creeping in before the end of 2023. More recently though, on the back of stronger real economy data, money markets have revised expectations for a possible peak in Fed funds up to 5.4 per cent, with little chance of a rate cut until 2024.
It’s provided a positive boost for US dollar sentiment, which has seen the trade-weighted currency index, representing the dollar against a basket of other major currencies, gaining ground to the tune of 4 per cent over the last month.
