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On Wednesday (July 12, 2023), the United States (US) dollar index dipped below 101.6, reaching its lowest point in two months, as market expectations grew that US inflation would continue to ease and the Federal Reserve would soon halt rate hikes.
Earlier in the week, several US central bank officials indicated that further rate increases would likely be necessary this year to combat persistently high inflation. However, signs are emerging that the end of the current tightening cycle is drawing near.
Simultaneously, the latest data revealed that US consumer inflation expectations for the coming year decreased for the third consecutive month, falling to 3.8% in June 2023 from 4.1% in May—the lowest level in over two years.
Moreover, economic optimism in the US unexpectedly declined to an eight-month low in July. Market participants are now awaiting the release of the June US consumer price index report, which is expected to shed light on the Federal Reserve’s progress in addressing inflation.
The US dollar experienced the most significant decline against the Australian and New Zealand dollars, while it reached an almost one-month low against the Japanese yen. ING’s Chris Turner noted that the dollar began the week on a weak note.
Although there hasn’t been much data, the influence of the Fed’s interest rate story versus the attraction of overseas asset markets is slightly working against the dollar.
Concerning the former, US short-term interest rates dropped 10 basis points yesterday during the European afternoon, seemingly in response to a New York Fed survey on consumer inflation expectations. In the one-year term, expectations reached their lowest levels since April 2021.
The market appeared to disregard three Federal Reserve speakers who all reiterated that the policy rate would likely need to be increased by another 25 or 50 basis points this year.
Regarding the attraction of overseas markets, there are indications that some modest support measures for the Chinese property sector could lead to broader support for the private sector this summer, sparking speculation. Asian equities are slightly bid today.
Turner highlighted a story in the Financial Times that may partially explain the current weak tone of the US dollar. The report suggests that hedge funds have significantly reduced their positions in US equities to the lowest level in a decade and are shifting their focus to undervalued European equities.
While there are multiple factors that influence foreign exchange rates, it can be argued that the dollar trading below what interest rate differentials suggest may be partially attributed to this rotation.
It is not expected that there will be significant currency movements today, but the US dollar index (DXY) could continue to drift toward the 101.50 area, according to Chris.
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