Traders looking ahead to US rate cuts in 2024, dollar under pressure

28 Dec 2023 , 09:37 AM

With markets gripped by prospects of Fed rate cuts next year, the dollar nursed severe losses on Thursday and appeared poised for a yearlong dip after two years of solid gains.

As the year draws to an end, there should be little movement until the New Year due to reduced liquidity.

The dollar index, which compares the value of the US dollar to six competitors, dropped to 100.81, a new five-month low. The index dropped 0.5% on Wednesday and is expected to fall 2.6% this year, after two years of solid gains.

Investor attention is still focused on when the Fed will cut interest rates; according to the CME FedWatch tool, markets are pricing in an 89% chance of a drop in March 2024. Up to 158 basis points of Fed easing are implied by futures for the upcoming year.

However, some experts are still sceptical that the US central bank will take such a strong stance.

Other major central banks, such as the European Central Bank, continued to maintain their position that rates must remain higher for a longer period of time, despite the Fed’s unexpectedly dovish approach at its December meeting, which could lead to rate cuts next year.

Still, markets are pricing in a potential 165 basis point rate drop from the European Central Bank for the upcoming year.

At $1.1113, the euro was up 0.09%, sitting just below the five-month high of $1.1122 reached on Wednesday. With a 3.7% annual rise, the single currency was on track for its best result since 2020.

At its peak on August 10, sterling was last trading at $1.2813. The pound is expected to rise by 6% this year, which would be its best result since 2017.

Given that inflation is greater in the UK than it is in the US, investors anticipate that the Bank of England will not be able to lower rates as much as the Fed and ECB. 

As a result, the yield on British bonds is now higher than those on US and European bonds, which has strengthened the pound and made them appear more appealing.

In the meantime, the value of the Japanese yen increased by 0.23% to 141.50 against the US dollar, edging closer to the five-month high of 140.95 it had hit earlier this month.

Dec. saw a 4% advance in the Asian currency versus the US dollar, putting it on track for its second straight month of gains due to growing speculation that the Bank of Japan may soon abandon its extremely loose monetary policy.

The governor, Kazuo Ueda, stated on Wednesday that he was not in a haste to remove the ultra-loose monetary policy because there was little chance of inflation rising above 2%. Nevertheless, the central bank remained true to its policy earlier this month.

The yen is down 7% against the dollar so far this year.

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