Last week, the US dollar experienced its biggest drop since 2009. The dollar index has accumulated a decline of 3% in two days after the latest inflation data released in the United States.
The CPI fell from 8% after the four increases of 75 basis points in the official interest rates in the United States. This may explain why inflation went from 8.2% to 7.7%, three tenths less than expected.
Is the dollar rally over? It depends. The Federal Reserve may be able to meet its inflation targets early. Today, the possibility that the December rate hike in the US will be 50 basis points instead of 75 basis points is around 70% when before the latest inflation data it was 50%.
Let’s remember that, so far this year, the US dollar has risen 12% against the main world currencies, as the main Forex indicators have collected. Specifically, the dollar has risen 22% against the Japanese yen, which keeps its interest rates unchanged, and 9.9% against the euro.
It is true that we are talking about the fastest and most aggressive rise in interest rates in the North American country since the 1980s. However, the fact that the rate of withdrawal of the stimuli can be reduced does not imply that the dollar will no longer have the support of new increases in rates or a restrictive monetary policy.
The end of the rate hike is not the end of restrictive monetary policy
In addition, for many economists, the fact that prices of goods start to fall is not the only key, since inflation or the rise in prices of services has not yet started, which will keep the reading of core inflation elevated for a while longer. weather.
It is necessary to watch, they say, the evolution of the labor market, because if it continues strong, the Fed will not be able to change its monetary policy and will continue to support the dollar in the Forex.
Some economists indicate that the level needed in the US to control inflation is set by core inflation measured through the private consumption deflator. Thus, they forecast that official interest rates will go to 5% in the second quarter of 2023.
Let’s remember that in the last decision of the Fed they raised 75 basis points, but it was stated that the economy could go into recession as long as inflation was brought to the 2% target. Powell already said then that the risk of falling short in increases was more costly than going overboard, since rates could always be lowered. In addition, those responsible for the Fed foresee higher interest rates than the references that were published in September in the famous dot plot (4.4% at the end of the year and 4.6% at the end of 2023).
Rate forecasts above 5%
Let’s go back to the forecasts, which is what matters in Forex: futures markets discount a terminal rate of 5.2% in May 2023, but with underlying inflation above 5%, rates could have to go a little higher. .
Thus, some factors that support the greenback remain. The Fed, as we have previously said, will maintain a restrictive monetary policy. And the risk aversion of the markets in the face of the war and the global situation favor the dollar as a refuge asset.
Despite this, this rise in the dollar against the main world currencies shown by the main Forex indices (20%) suggests that we are going to experience a certain stabilization of the dollar. This makes the greenback a Forex asset with predictable neutral behavior in the short term, with 1.07 units as the level to watch.
Some forecasts still place interest rates in the US above 5% in 2023 (4.75%), but we already say that they may fall short. That would imply that the level of 0.95 units in the eur/usd would be its lowest level in 2022 and that the eur/usd pair will rise to 1.05 units in 2023 and to 1.10 units in 2024.
Other estimates point to a eur/usd around the range 0.9-1.00 units at the end of 2022, but very similar levels by the end of 2023. In both cases, the eur/usd range leaves little room for operating short in the pair and makes it more interesting to look for greater volatility in the Forex in other currency pairs with wider spreads where you can obtain a certain return.
It seems that the answer to the question that Forex asks if the dollar has peaked is yes. What is not so clear is how long the greenback will stay at these levels, as core inflation takes longer to come down and it is quite possible that it will stay at these levels longer than expected.