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US Dollar Outlook – Dancing to The Fed’s New Soundtrack

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Federal Reserve chair Jerome Powell outlined the road ahead for tighter US monetary policy on Wednesday by starting a series of interest rate hikes and highlighting how the central bank will start reducing its $9 trillion balance sheet. The task ahead for chair Powell will be tricky as he tries to rein back multi-decade high levels of inflation without crimping growth in the months ahead.

The difficulty that the Fed is facing over the coming months is shown clearly by a closely watched measure of US Treasury yield expectations, the 2-year/10-year UST spread. The flatter the curve between these two US Treasuries, the greater the market expectation that growth will slow in the quarters ahead. The spread is currently quoted at just 24 basis points, its narrowest level in over two years, suggesting that rate cuts will be needed sometime next year, unless inflation and growth follow the Fed’s current thinking.

US Dollar Outlook – Dancing to The Fed’s New Soundtrack

The US dollar has been moving higher over the last few months in anticipation of tighter US monetary policy, namely higher rates. Higher US interest rates will draw overseas investors towards the US dollar, pushing its value higher, especially against currencies with a lower interest rate. Since mid-May, when the Fed first openly recognized that a series of interest rate hikes were needed to counter inflation, USD/JPY has risen from around 109.00 to a current level of 119.25, GBPUSD has fallen from 1.4200 to 1.3150, while EURUSD has dropped from 1.2250 to 1.1025. Looking ahead, the US dollar is likely to continue to appreciate against a wide selection of other currencies although the speed and the extent of this appreciation will be more gradual as other countries start their own rate hiking cycle.

The weekly US dollar basket (DXY) chart highlights the recent USD strength and suggests that further gains are likely going forward. The greenback continues to make fresh higher highs and higher lows, suggesting that the DXY remains a ‘buy the dip’ market, while a full recovery back to its pre-pandemic high (103.98) would see the dollar rally by another five big figures. The Fed’s latest actions and guidance have given the US dollar room to run a lot higher.

US Dollar Outlook – Dancing to The Fed’s New Soundtrack

What is your view on the US Dollar – bullish or bearish?? You can let us know via the form at the end of this piece or you can contact the author via Twitter @nickcawley1.

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