Foreign Currency

Inflation fear rising as US dollar, yields move higher

FOMC, Powell “need greater confidence” on inflation

Federal Reserve Chair Jerome Powell has expressed a need for “greater confidence” in the fight against inflation, citing a “lack of further progress” towards stabilizing the US inflation rate around the 2% target. This statement raises concerns about the expected cuts in 2024, hinting that it could be several months before a rate cut.

Treasury yields near 5.0%

Treasury futures have escalated, with the 2-year yield approaching multi-year peaks of around 5.0% experienced in October 2023. This ascent in yields reflects market anticipation of continued rate firmness, which could strengthen the US dollar’s position in the forex market.

US dollar surging on higher rates, flight to quality

Amidst higher interest rates and global uncertainties, the US dollar has reached new heights against major currencies like the Japanese yen, eur, British pound, and Australian dollar, underscoring a “flight to quality” phenomenon. The dollar is drawing demand from investors overseas as a result of escalation of war in the Middle East, and from investors wishing to buy Treasuries because of their elevated yields.

Inflation can move higher

Historical precedents from the 1970s and 80s show inflation rates rising and falling in cycles, mirroring current patterns where inflation remains persistently high. Notably, inflation fell from 12% in 1974 all the way to below 5% – before rising again, peaking above 14% in 1980. While the Fed has been successful so far lowering inflation from 9% in 2022 to our current level at 3.5%, investors worry this historical context does not rule out the possibility of inflation rising once again despite high interest rates.

Interest rate cuts less likely in 2024

As a result of recent data, the probability of the Fed implementing one or no quarter-percent cuts to the current 5.5% Federal Funds rate is nearing 50% (CME FedWatch tool). This outlook is severely higher than at the start of 2024, when projections favored 6-7 25bps cuts in 2024. These shifts impact forex trading decisions, as traders recalibrate expectations for US dollar strength and currency pair movements.

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