The dollar’s return to strength

Feb 8, 2023
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The foreign exchange market has been quite turbulent in recent days with central bank meet...

The foreign exchange market has been quite turbulent in recent days with central bank meetings. Unsurprisingly, banks raised their key rate with a 0.25% hike for the Fed, and a 0.50% hike for the ECB and the Bank of England. As a result, the Fed’s key rate was brought to the 4.50% - 4.75% range, after this eighth consecutive (although smaller) increase. Further increases are still to be expected and the peak could be reached by the summer, according to the institution. Fed Chair Jerome Powell noted that inflation has slowed somewhat, but remains high. The greenback came under pressure following the announcement and the euro reached a high of 1.1033 on the assumption that the rate spread between the two currencies would become less favourable to the greenback. The next day, the European Central Bank followed the Fed by raising its rates as expected by 0.50% to bring the deposit rate to 2.50% and the preferential refinancing rate to 3%. Even though the ECB hinted at another hike for 16 March, the market was not excited by the central bank’s statements and began to take profits by selling the single currency to bring it back to the 1.0900 dollar mark against the euro. This trend was set to intensify again on Friday afternoon with the publication of employment figures in the United States, which were well above expectations, with 517,000 new job vs. 260,000 expected. The unemployment rate now stands at a 53-year low of 3.4%. The prospect of the Fed continuing its hiking cycle for longer than expected, perhaps beyond the summer, has put the dollar back on its upward path. This is in any case the perception that Raphael Bostic, President of the Atlanta FED. In an interview with Bloomberg he said: ‘If a stronger-than-expected economy persists, it’ll probably mean we have to do a little more work. And I would expect that that would translate into us raising interest rates more than I have projected right now’. Mr Bostic stated that his base case scenario remains for the rate to reach 5.1% and remain there throughout 2024. A higher peak could come from an additional increase of a quarter point above the two currently envisaged, without ruling out a half-point increase, according to him. In any case, the euro’s upward momentum has been broken and the 1.1033 level could be as high as it will go in the near future.

As has been said, the ECB raised its benchmark rate by 50 basis points and suggested a similar decision at the next meeting in March. For the Slovak and Latvian governors who were speaking in an official statement, rates should continue to rise even after 16 March. For the Governor of the Banque de France Villeroy de Galhau, a return of inflation towards 2% is not to be expected before the end of 2024 at the beginning of 2025. This suggests a period of ‘high’ rates for a while and that a return to ultra-low rates as seen in recent years is unlikely.

US figures also impacted the bond market. The yield on the 10-year US government bond rose to 3.649% after falling to 3.30% last week. It was the same in the eurozone, where bonds fell after the ECB’s decision. The German Bund jumped from 2.067 % to 2.36%, while the 10-year Confederation yield rebounded to 1.318%.

The Bank of England raised its base rate by 50 points to 4%. It has not announced future increases but will continue to act if inflationary pressures remain strong. And a similar move took place at the Reserve Bank of Australia, which raised its main key rate by 0.25% to 3.35%. Governor Philip Lowe also said he expects several further rate hikes in the coming months. This is the ninth hike by the RBA. Their 2%-3% inflation target will probably not be reached before 2025. The fight against inflation is also happening in India, where the Reserve Bank of India raised rates by 0.25% –to 6.50% – this morning without ruling out further hikes in the future. The Bank has already raised rates by 250 basis points since last May.

Gold has also had a few turbulent days in the wake of central bank decisions and unemployment figures. Taking advantage of the dollar’s weakness, the ounce of gold rose to $1,959 before drastically changing course and plunging to $1,861, i.e. a loss of almost $100 between Thursday and Monday. The reason? Profit taking due to new expectations on US rates.