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The dollar is slumping before the Fed hikes interest rates again as a run of soft economic data is keeping rate-cut expectations alive

Feb 2, 2023, 00:49 IST
Business Insider
The US Dollar index has been drifting lower.EVA HAMBACH/Getty Images
  • The US Dollar Index is down Wednesday just before the Federal Reserve is set to hike up interest rates for the eighth straight time.
  • The greenback is being dragged down by weaker economic data that stokes rate-cut expectations.
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A widely watched US dollar gauge dropped Wednesday, unable to gain traction before the Federal Reserve is expected to raise interest rates again, as economic data stoked expectations that rate cuts are on the way later in 2023.

The US Dollar Index on fell 0.4% to 101.68, on track for its lowest close in a week. The euro and the Japanese yen were higher against the greenback, doing the heavy lifting on the index that tracks the dollar's performance versus six rivals. The index hit a 20-year high last year.

The decline came just before the Federal Open Market Committee was expected to kick up its benchmark interest rate for an eighth consecutive time Wednesday. The pace of the rate hike, however, is expected to be reduced to 25 basis points from 50 basis points as inflation rates come off hotter levels.

The foreign exchange market appears to be heading into a volatile 24-hour period as the Bank of England and the European Central Bank are projected to also continue rate hikes on Thursday, Fawad Razaqzada, market analyst at FOREX.com, wrote in a note. The trends for the euro and the British pound were bullish heading into those central bank meetings, he said.

Higher interest rates can boost the appeal of a fiat currency, but new data showing a slowdown in economic activity is sustaining market speculation the Fed will embark on rate cuts later this year.

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"Fed Chair [Jerome Powell] is likely to keep further hikes on the table and lean against bets they will cut later this year, something which may get interpreted as being hawkish. But as we have seen in recent Fed meetings, the market has been quick to dismiss the Fed's hawkishness and price in a lower terminal interest rate," Razaqzada wrote.

A rally in US stocks and Treasury bonds in January highlighted expectations the Fed may pivot to rate cuts as a recession looms. The Fed is expected to raise its benchmark rate to 5.1% by the spring. Fed funds futures pricing indicates investors widely expected the Fed to switch to rate cuts later this year.

Economic data released Thursday "are largely consistent with a cooling economy," Bill Adams, chief economist at Comerica Bank, wrote in a note.

ADP said private-sector hiring increased by 106,000 in January. The print was less than the 158,000 expected in an Econoday consensus estimate. Hiring last month was hampered by inclement weather, ADP said.

Meanwhile, manufacturing-sector activity shrank in January, the third straight month of contraction, the Institute for Supply Management said. Its manufacturing PMI fell to 47.4%.

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There was an upside surprise in the Labor Department's job openings report, which showed an increase to 11.012 million versus projections of 10.3 million. But Adams noted that data point was "a bit of an outlier."

"The big question of the day is still how Chair Powell will react to the loosening of financial conditions since December and whether the Fed will push back against financial market expectations for a pivot in monetary policy later this year," he said.

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