The U.S. currency could strengthen steadily since May 2021, when the USD index started near 89 points and crossed 94 points last week. This implied a potential appreciation of more than 5 percent.
The strong appreciation of the USD could be driven mainly by the anticipation of the Federal Reserve's action, namely the increased chances of tapering as early as this November and possible interest rate hikes in the second half of 2022. In other parts of the globe, the market generally did not price in the possibility of an interest rate increase during the same period. The Fed was expected to be one of the first major banks to make such a decision. However, the situation seems to be changing.
The last few days have brought one of the biggest waves of the dollar sell-off, and the EUR/USD exchange rate in a relatively short period returned from the area of 1.1520 to 1.1650. The currently observed weakness of the USD and its pace seems comparable to what was observed in the second half of August.
Strong rise in interest rate hike expectations moves the forex market
Expectations of a 50 basis point rate hike by the central bank of New Zealand (RBNZ) have intensified due to rising inflation. Recently, Bank of England Governor Andrew Bailey also hinted at the possibility of an earlier interest rate hike, saying on Sunday that the central bank must act to curb rising inflationary risks. Yields on 10-year bonds in the U.K. and New Zealand have risen faster than yields on 10-year bonds in the U.S.
According to JP Morgan, the Bank of England could raise its main interest rate by 15 basis points as early as November this year. The money market, in turn, values the possibility of an increase to 50 basis points as early as in December. The next BoE meeting is scheduled for November 4, and the main interest rate there currently stands at 0.1 percent.
The New Zealand dollar and the British pound appear to be at the forefront of currencies strengthening against the USD. The NZD gained nearly 2.9 percent to the USD in the last quarter, while the GBP strengthened by nearly 0.8 percent.
Investors have become heavily involved in USD contracts
How investors position themselves in the US currency index futures market could also be a significant risk factor for the USD. According to CFTC data, in the week ended October 12, the advantage of long positions over short positions among speculators was the largest in two years. If the dollar does not start to significantly strengthen, investors may feel disappointed with their decisions, which may ultimately lead to closing long positions, which could lead to a decline in the value of contracts and the USD itself.
Daniel Kostecki, Director of the Polish branch of Conotoxia Ltd. (Forex service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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