The U.S. dollar’s recent bounce is fading, encouraging bears who expect the currency to see only fleeting periods of gains in the months ahead.
The dollar bounced strongly versus major counterparts after last week’s jaw-dropping employment data, boosting the greenback’s appeal as a safe-haven currency as investors re-evaluate bets on how high the Federal Reserve will raise rates to put a lid on inflation.
The ICE U.S. Dollar Index DXY,
The index jumped 1.1% to 102.92 on Friday following the jobs data and rallied to one-month high of 103.96 on Tuesday after Fed Chair Jerome Powell said more interest rate rise will be needed to cool inflation and the red-hot U.S. jobs market.
The rally made investors wonder whether a still-hawkish Fed could keep the dollar supported and help it regain all the losses made in the past four months, after it ended a surge that took the index to a 20-year high. The dollar index has fallen 8.7% since mid-October after rallying for most of 2022, according to Dow Jones Market Data.
See: How the U.S. dollar could put this stock-market rally to a big test
Steve Barrow, head of G-10 strategy at Standard Bank, doesn’t think the Fed’s commitment to wringing inflation out of the economy will put a rocket under the dollar.
“As long as the market is sure that the Fed is at, or close to, the top in the rate cycle, and can still see the prospect of cuts next year, the dollar should fall — as long as this policy position does not undermine asset prices, such as stocks,” Barrow said in a Tuesday note.
“In our view, the risk of a significant and prolonged dollar surge from monetary policy alone comes if the Fed proves to be behind the inflation curve again because labor market pressure, and perhaps other factors, cause a re-acceleration of inflation that threatens multiple rate hikes,” he added.
Barrow and his team acknowledge that the Fed may have to take rates “marginally higher” than the market consensus, which could aid the dollar, but the central bank is unlikely to hold that rate for longer.
Traders projected a 68% probability that the fed-funds rate will reach 5-5.25% by May. They also anticipated 25 basis points of rate cuts by the end of 2023, according to the CME’s FedWatch tool.
Barrow and his team think there will be some “periods through the year” when the dollar strengthens, which is possibly due to adjusted Fed rate expectations, but “these bumps in the road should not change the general direction in our view, which is for a weaker dollar in 2023,” and these “comebacks” will not be strong enough to embolden the dollar to test its 2022 highs.
The dollar index surged 19% in the first nine months of 2022 and hit a peak of 114.78 in late-September.
Charalampos Pissouros, senior investment analyst at XM Investment, said that any further recovery of the U.S. dollar in the near term might be at risk as more crucial economic data comes out next week.
The January inflation data which is due out next Tuesday, is expected to show both the headline and core CPI numbers continued to decline, which could “revive speculation about a lower peak in U.S. interest rates as well as more rate cuts for later this year,” Pissouros wrote in a Wednesday note.
“U.S. Treasury yields may come under renewed pressure and thereby the dollar could be sold again,” he added.
U.S. stocks traded higher on Thursday with the Nasdaq Composite COMP,
