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Multiple supporting factors: The U.S. dollar exchange rate may remain relatively strong in the short term

2024-02-20

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Entering 2024, the strengthening of the US dollar seems a bit unexpected. However, upon careful analysis, there are still many supporting factors behind it. Market participants believe the U.S. dollar is still likely to remain relatively strong in the coming months.

Due to the sudden "dove" sound of the Federal Reserve after its interest rate meeting in December last year, the market's expectations for an interest rate cut in March this year suddenly increased, and the US dollar experienced a wave of decline. The US dollar index closed slightly lower in 2023.

Unexpectedly, the U.S. dollar exchange rate has strengthened since the beginning of this year. As of February 16, in just one and a half months, the U.S. dollar index rose by 3%, hitting a three-month high.

Analyzing the recent reasons for the rise in the US dollar, it is mainly affected by both internal and external factors.

Looking at domestic factors in the United States, inflation has slowed less than expected, and expectations for a March interest rate cut by the Federal Reserve have weakened.

Rising housing costs and service industry prices drove the U.S. Consumer Price Index (CPI) to rise more than expected in January. In January, CPI rose 0.3% month-on-month, the largest increase since September last year; it rose 3.1% year-on-year, higher than the market consensus of 2.9%. The January PPI data released three days later also exceeded expectations across the board. The January PPI rose 0.9% year-on-year, higher than the 0.6% expected; it rose 0.3% month-on-month, compared with the expected 0.1%, which once again suppressed market bets on the Fed's recent interest rate cut. .

Bank of America Global Research said that CPI data further strengthened concerns about inflationary pressure caused by tight labor markets. The possibility of the Federal Reserve cutting interest rates in March and May has declined, and it is expected to start cutting interest rates in June. Greg Barsuk, CEO of AXS Investments, believes that the current outlook is that the Fed seems more likely to delay cutting interest rates until the second half of the year.

The Chicago Mercantile Exchange Fed Watch Tool shows that the expected probability of no interest rate cut in March remains unchanged, and the probability of no interest rate cut in May has dropped from 61% to 57%. In June, the market is still pricing in the expectation that the Fed will start to cut interest rates. point in time.

The postponement of the Fed's expected interest rate cut has obviously pushed back the timing of the narrowing of interest rate differentials between the U.S. dollar and other currencies. The market's correction of U.S. dollar pricing has supported the recent trend of the U.S. dollar.

However, the January retail sales data released by the Census Bureau of the U.S. Department of Commerce fell by 0.8% month-on-month, which was significantly weaker than market expectations for a decrease of 0.1% to 0.3%. At the same time, the retail sales data in December last year was also revised down from a month-on-month increase of 0.6% to 0.4%. %, which to some extent alleviated market concerns about overheating consumption driving inflation. However, analysts also believe that the weakening retail sales in January may be related to the advance consumption caused by the previous month's promotions.

Despite the interference of weakening retail sales, from the perspective of foreign factors, the economic performance of Japan and Europe is even weaker, which still provides support for the US dollar exchange rate.

Japan's sluggish domestic demand, especially the decline in private demand, has offset the positive driving effect of export growth on the economy, and the Japanese economy has unexpectedly shrunk for two consecutive quarters. After falling by 0.8% quarter-on-quarter in the third quarter of last year, Japan's gross domestic product (GDP) fell by 0.1% quarter-on-quarter in the fourth quarter. Based on this, it can be preliminarily judged that Japan's economy has fallen into a technical recession again.

A Bloomberg survey of economists last month showed that most respondents had expected the Bank of Japan to raise interest rates in April for the first time since 2007. But economic data was worse than expected, adding uncertainty to the Bank of Japan's plan to exit its ultra-loose policy. The Bank of Japan is likely to keep its loose policy unchanged in the short term, which puts pressure on the yen exchange rate.

In Europe, the euro zone’s economic growth has hovered near zero for six consecutive quarters. European Central Bank President Christine Lagarde said economic activity will remain sluggish in the short term. The European Commission recently lowered its 2024 GDP growth forecast for the euro zone from 1.2% to 0.8%, which is only slightly higher than the 0.5% growth rate in 2023.

Although the European Central Bank's next interest rate action is likely to be a rate cut, the economic downturn has slowed inflation concerns and the European Central Bank is not in a hurry to take this action. Judging from Lagarde's words, if the ECB moves too quickly, inflation may rise again, which may force the ECB to tighten policy again, which will be a costly iteration.

Given that the U.S. economy is still at a relative advantage compared with the economies of other major developed economies, this round of dollar strength has received certain support.

There are still some differences in the market regarding the future trend of the US dollar.

Paul Merkel, global head of foreign exchange research at HSBC, believes that the dollar will be stronger this year, but it will not be as unusually strong as in 2021 and 2022. George Saravelos, global head of foreign exchange research at Deutsche Bank, said the real debate is not when the Fed starts cutting interest rates, but whether the Fed will cut interest rates smaller or larger than the rest of the world over the next two years. "We continue to believe the risks are tilted toward less easing from the Fed and therefore positive for the dollar."

However, after the early rise, the dollar's short-term upward momentum may be limited. Citi FX's "Pain Index", which tracks the positions of active foreign exchange traders, shows that these traders have sharply cut their bullish bets on the dollar and remain basically neutral.

In the short term, if there are no special factors, the US dollar will remain relatively strong against the currencies of other major developed economies. Given that there are still uncertainties about the economic performance of various countries and the timing of monetary policy adjustments, the trend of the US dollar throughout the year remains to be seen.

The above information is provided by special analysts and is for reference only. CM Trade does not guarantee the accuracy, timeliness and completeness of the information content, so you should not place too much reliance on the information provided. CM Trade is not a company that provides financial advice, and only provides services of the nature of execution of orders. Readers are advised to seek relevant investment advice on their own. Please see our full disclaimer.

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Multiple supporting factors: The U.S. dollar exchange rate may remain relatively strong in the short term

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