In a downward trend, the dollar slides as market participants factor in 100 basis points worth of Federal Reserve rate cuts. While the US economy is expected to slow down, it is still anticipated to outperform its major counterparts. The Fed is likely to reduce rates next year, with the European Central Bank possibly cutting rates earlier. The Australian dollar is expected to be the top performer against the greenback.
The dollar faced significant downward pressure this past week due to the US Consumer Price Index data showing lower than expected inflation in October. This added to the belief held by investors that the Fed’s tightening measures are coming to an end, despite recent statements from Chair Powell and other officials pushing back against these expectations. This follows another blow to the dollar after a disappointing jobs report for October. Given that the Fed’s monetary policy decisions are impacted by inflation and the labor market, weak conditions in both areas led market participants to rule out the possibility of another rate hike this year and to forecast around 100 basis points worth of rate cuts for next year.
Data does not currently support such a significant rate cut for next year, as projected growth rates for Q4 2022 range from 2.2% to 2.5%. Rates at current levels and a 4.9% growth rate in Q3 indicate a normal slowdown. Despite this, the Fed could begin cutting rates and maintain a tight monetary policy, steering inflation in the preferred direction. If data continues to indicate a faster than anticipated decline in inflation, the Fed may decide to start cutting rates earlier to avoid a more severe economic slowdown. The Fed’s September forecast suggests one more hike and expects rates to end 2024 between 5.00-5.25%, reflecting a deviation from market expectations.
The Fed’s economic forecasts do not justify 100 basis points worth of rate cuts, and incoming data suggesting that the US economy is faring better than its counterparts may convince investors to adjust their expectations. While a bearish reversal for the dollar is not imminent, the Eurozone and the UK’s economic conditions could lead to the European Central Bank and the Bank of England cutting rates before the Fed, impacting the euro and the pound. Meanwhile, the Australian and New Zealand dollars, as well as the Japanese yen, may outperform the dollar, particularly as expectations of Fed rate cuts drive increased risk appetite.
Ultimately, the dollar may continue to slide in anticipation of rate cuts by the Fed, but the extent of these cuts remains uncertain. The economic conditions of major peers and central bank policies will also play a significant role in the dollar’s performance against other currencies.
