The robust beginning of the year for the US dollar, marking its strongest rally in more than a decade, encountered a setback as speculators entered into positions against the currency. This sentiment stems from the belief that a slowdown in inflation will prompt the Federal Reserve to initiate interest rate cuts in the course of the year. The Bloomberg dollar spot index, which had surged by 1% in the initial four days of the year, experiencing the most significant first-week gain since 2011, faced a pullback for the second consecutive day on Monday. This retracement coincided with the decline in US Treasury yields, which had risen after a notable fall in the last two months of 2023 amid growing speculation of an imminent monetary policy easing by the central bank. The efficacy of these speculations will be put to the test with the release of the monthly consumer price index on Thursday and producer price data on Friday.
Market strategist Charu Chanana from Saxo Markets highlighted in a note on Monday that the Fed’s rate cut expectations are undergoing reassessment, emphasizing the market’s sensitivity to hawkish data surprises. While a tactical US dollar recovery might be possible this week, Chanana noted that a structural downtrend remains, with the probability of a rate cut in March still high.
Last week’s advance in the dollar was a modest rebound from its significant decline since the onset of the Treasury rally in November, with the index registering a 0.3% drop on Monday.
The trajectory of the currency moving forward will heavily depend on whether traders have overestimated the extent of the Fed’s interest rate cuts in the coming year. Currently, the futures market is pricing in the possibility of the central bank cutting its benchmark by nearly 1.5 percentage points in 2024, with the first move potentially occurring in March.
Data released by the Commodity Futures Trading Commission on Friday revealed that non-commercial traders, including hedge funds and asset managers, increased their short bets on the dollar to the highest level since late August.
Tom Fitzpatrick, Managing Director of Global Markets Insights at R.J. O’Brien & Associates, pointed out that the dollar’s future direction is contingent on the interplay of rising yields, falling equities, and the potential for further USD support.
