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Dollar Recovers, But U.S. Inflation Print Holds the Key PHOTO: REUTERS |
Dollar recovers as traders scale back bets of big Fed rate cut following last week's mixed U.S. jobs report, which left investors uncertain about the Federal Reserve's next policy move. On Monday, the dollar rebounded against major currencies, particularly the yen and Swiss franc, as traders braced for this week's critical U.S. inflation data release. With market participants revising their expectations for the size of the Federal Reserve's rate cut at the upcoming September meeting, the U.S. dollar saw gains amid global currency fluctuations.
This development comes at a time when the global economic landscape is shifting, driven by inflation concerns, central bank policies, and a complex labor market picture in the U.S. In this comprehensive post, we will explore how these factors are shaping the dollar's recovery and what to expect as the U.S. Federal Reserve prepares for its next move.
The Dollar's Rebound Amid Mixed Economic Signals
The U.S. dollar experienced a notable recovery as traders pulled back on expectations for an aggressive 50-basis-point (bps) rate cut by the Federal Reserve. Following Friday's U.S. jobs report, which showed slower-than-expected employment growth but a lower unemployment rate, investors were left in a state of uncertainty regarding the Fed’s next steps.
As of Monday, the dollar index, which measures the greenback against a basket of six major currencies, was up 0.41%, reaching 101.61. The yen, traditionally seen as a safe-haven currency, weakened by more than 1% to 143.56 per dollar. This marked a significant retreat from the one-month high of 141.75 yen per dollar, which it hit last week when worries over the U.S. economy spurred demand for safer assets.
The Swiss franc, another currency considered a safe haven, also fell 0.7% to 0.8489 per dollar, retreating from its eight-month high. The mixed U.S. jobs data from Friday provided little clarity on whether the Fed would opt for a 25-bps or 50-bps rate cut at its September 17-18 policy meeting. As traders await further economic indicators, the U.S. inflation print scheduled for Wednesday is expected to be a critical data point.
How the U.S. Inflation Report Will Impact the Fed’s Decision
This week’s U.S. inflation report is expected to be a pivotal moment in shaping Federal Reserve policy. Investors will closely examine the August Consumer Price Index (CPI) figures to gauge the future course of interest rates. The outcome of the report will directly influence the size of the expected rate cut.
If inflation numbers come in lower than expected, it could bolster the case for a larger 50-bps rate cut, which would weaken the dollar. On the other hand, if inflation aligns with or exceeds expectations, it may solidify the chances of a smaller, 25-bps rate cut, which is already priced into the markets.
Graph: U.S. Inflation Data and Dollar Index Performance
A graph illustrating the relationship between key U.S. inflation prints and the dollar index performance in 2024.
This chart demonstrates how inflation reports have historically influenced the dollar’s trajectory. Investors should keep a close watch on the upcoming report as it could determine the market's short-term outlook for the U.S. dollar.
Impact of the Fed's Rate Cut on the Dollar
The Federal Reserve's potential rate cut has been a hot topic for weeks. A 25-bps rate cut seems highly probable, but the chances of a more significant 50-bps cut have been reduced following Friday’s mixed jobs report. While the employment data showed slower growth, the dip in the jobless rate to 4.2% and solid wage growth suggested that the U.S. labor market remains resilient, albeit not strong enough to trigger panic.
MUFG strategist Lee Hardman remarked that the initial relief rally for the U.S. dollar was driven by traders scaling back their expectations of a larger rate cut. Markets, which had previously priced in a 50% chance of a 50-bps cut, have since adjusted their expectations to around 25%.
Despite these adjustments, Fed policymakers have signaled a readiness to cut rates, with some officials suggesting that a cooling labor market could warrant more aggressive action if economic conditions deteriorate. If the inflation data shows a sharp decline, Fed Governor Christopher Waller and other policymakers have indicated that a larger cut could still be on the table. However, a smaller 25-bps cut remains the baseline expectation.
Global Currency Markets: Yen and Swiss Franc Decline
As the U.S. dollar recovered, global currencies experienced significant movement. The Japanese yen, which is often seen as a safe-haven currency during times of economic uncertainty, fell sharply, retreating from last week's highs. This drop was driven by reduced fears of a U.S. economic slowdown following the jobs report and scaled-back expectations for a large Fed rate cut.
Similarly, the Swiss franc, another currency used by investors seeking safety, lost ground against the dollar, falling to 0.8489. It had previously reached an eight-month high amid concerns over global economic risks. With the dollar showing signs of recovery, these safe-haven currencies faced downward pressure.
Euro, British Pound, and Other Currencies: Reactions to Central Bank Moves
The euro slipped 0.4% against the dollar, trading at $1.10428, as traders looked ahead to the European Central Bank’s (ECB) upcoming policy meeting. The ECB is expected to cut rates by 25 bps to 3.50%, having initiated its rate-cutting cycle earlier this year. Traders have priced in a 52% chance of an additional cut in December.
"The ECB path is much clearer than the Fed, having already started its rate-cutting cycle," said Mohit Kumar, chief economist for Europe at Jefferies. The ECB’s consistent cuts have provided the market with greater certainty, in contrast to the more data-driven approach of the Federal Reserve.
In the U.K., the British pound weakened by 0.3%, hitting a two-week low of $1.3087. The pound’s decline comes ahead of a slew of U.K. economic data releases, which could impact the Bank of England’s policy decisions for the remainder of the year.
Meanwhile, the Norwegian and Swedish crowns also fell against the dollar. The Norwegian crown touched a four-week low of 10.81 per dollar, while the Swedish crown dropped to a three-week low of 10.37 per dollar. These moves reflect the overall strength of the dollar as traders recalibrate their expectations ahead of the U.S. inflation report.
Conclusion:
As the dollar recovers with traders scaling back bets of a big Fed rate cut, all eyes are on the upcoming U.S. inflation report, which will play a crucial role in determining the size of the Federal Reserve's rate cut at its September policy meeting. The mixed U.S. jobs data from last week has left investors uncertain about the Fed’s next move, but a clearer picture is expected to emerge once the inflation data is released.
Global currency markets have already reacted to these developments, with the yen, Swiss franc, euro, and pound all experiencing fluctuations as the dollar strengthens. While a 25-bps rate cut remains the most likely scenario, a lower-than-expected inflation reading could lead to more aggressive action by the Fed, potentially impacting the dollar's performance in the coming weeks.(alert-success)
As the U.S. dollar continues to recover, market participants should remain vigilant, as the inflation report will likely determine the future direction of both U.S. monetary policy and global currency markets.
Graph: Dollar Index and Major Currency Performance in 2024
A graph showcasing the performance of the U.S. dollar index alongside major currencies such as the yen, euro, and pound over the past year.
This graph highlights the fluctuations in major currencies relative to the dollar and how global monetary policies influence currency exchange rates.
