The US dollar has staged a powerful rally to start 2023, rising to its highest level since June against a basket of major currencies. According to analysts, the greenback’s strength reflects growing conviction that the Federal Reserve will keep interest rates higher for longer to combat inflation.
Dollar Index Hits 7-Month High
The ICE US Dollar Index, which measures the dollar against six major currencies, climbed to 105.27 on Friday – its highest level since June 2022. The dollar gauge started the year below 104 but has gained over 1% in the first trading week of 2023 (source).
Fueling the dollar’s ascent are rising US Treasury yields and moderating expectations for Fed rate cuts later this year. The benchmark 10-year yield reached 3.72% this week, its highest since November, diminishing the allure of assets priced in the US currency.
Meanwhile, Eurodollar futures show that traders have pared back bets on rate cuts in 2023. At the start of December, markets were pricing in rate cuts totaling 75 basis points this year. That expected easing has now fallen to 25 basis points as policymakers emphasize that rates need to remain restrictive for some time to bring down inflation (source).
Dollar Gains Against All G10 Currencies
The robust dollar rally is evident across currency pairs. The greenback is higher against all G10 currencies so far in 2023. Some of the biggest moves have come against the Swedish krona (up 4.3%), New Zealand dollar (up 3.8%), and Australian dollar (up 3.6%) (source).
The euro has also weakened markedly from around $1.07 to $1.05 amid signs that Eurozone inflation may be stickier than anticipated. December CPI for the currency bloc rose 9.2% year-over-year, faster than the 8.9% rate markets had forecast. The report led money markets to trim the probability of ECB rate cuts later this year.
Meanwhile, sterling has faced selling pressure as the UK economy shows further signs of strain. Services and composite PMIs unexpectedly contracted in December, pointing to an economy already in recession. The weaker data has traders doubting whether the Bank of England can continue hiking rates to combat inflation now above 10%.
What’s Next for Dollar, Fed Policy?
The key question going forward is whether the US dollar can extend gains amid an already quite hawkish Fed stance. Markets expect rates to peak around 5% in March, and Fed officials have stressed they will need to keep policy restrictive for some time.
That messaging clashes with rising recession risks that could eventually force the Fed to cut rates to support growth. Former Treasury Secretary Larry Summers puts the odds of a US recession this year at over 50%. If growth slows significantly, markets may continue to trim some rate cut expectations, limiting upside for the dollar.
Several other risk events also loom that could spark dollar volatility. Chief among them is Friday’s US jobs report. Economists expect nonfarm payrolls rose by 200,000 in December while the unemployment rate held steady at 3.7%. An upside surprise would likely further boost Fed tightening bets.
Geopolitics also remain crucial, especially regarding China’s reopening. Further easing of China’s zero-COVID policies could boost global growth and weaken dollar demand. However, any virus resurgence leading to lockdowns would favor save-haven flows into the greenback.
| Date | Event | Impact |
|---|---|---|
| January 6 | US Nonfarm Payrolls (Dec) | Significant |
| January 10 | US CPI (Dec) | Very High |
| January 19 | ECB Rate Decision | High |
| January 25 | Fed Rate Decision | Extreme |
In summary, the US dollar has powered higher against all major rivals to start 2023 amid climbing yields and reduced expectations for Fed rate cuts. While upside appears somewhat limited given already aggressive tightening priced in, key data and events pose risks of further greenback gains. The dollar remains the top-performing G10 currency as the Fed keeps policy restrictive until inflation moderates significantly.
To err is human, but AI does it too. Whilst factual data is used in the production of these articles, the content is written entirely by AI. Double check any facts you intend to rely on with another source.
