The dollar index rose above the 104-point level on Monday, reaching a new 20-year high, as expectations for further monetary tightening by the Federal Reserve to fight inflation may continue to rise.
One market measure of U.S. interest rate expectations, the yield on the 10-year Treasury note, rose to 3.15 percent today, while market expectations based on the federal funds rate futures seem to point to the possibility of a peak in the hike cycle at 3.5-3.75 percent. Thus, the market may be close to fully discounting monetary policy tightening in this cycle, and this in turn may mean that space for any further strengthening of the USD may be shrinking. On the other hand, in addition to rising interest rates, global uncertainty still remains and the USD may be acting as a safe haven.
There still seem to be concerns about the pace of global GDP growth, there could be a slowdown or stagflation. There is still a lot of uncertainty about the inflation outlook, Russia's war with Ukraine is ongoing, and there are still Covid restrictions in China. These factors may generate demand for the US dollar. It is worth recalling that last week the Fed raised the interest rate by 50 basis points, and the employment report reinforced expectations for another big hike. Investors are now waiting for inflation data to be released on Wednesday to gain insight into possible next steps by the US central bank. Futures markets are pricing a 75 basis point interest rate hike at the next Fed meeting in June and more than 200 basis points of tightening by the end of the year.
Expectations for interest rate hikes also appear to be important for stock market indexes. The Nasdaq 100 is down more than 23 percent since the beginning of the year, which historically can correlate with a strong rise in inflation. Typically, as inflation rose, stock market indexes fell and reached their bottom when inflation peaked. Hence, Wednesday's data may be important from the perspective of stock market investors. Moreover, the peak in inflation may also cool expectations for larger hikes than currently expected, which could also weigh on the USD. While inflation has not yet peaked, the market trends observed since the beginning of the year may continue.
Daniel Kostecki, Director of the Polish branch of Conotoxia Ltd. (Forex service)
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