A nearly 30% reversal in the key U.S. dollar index from its post-pandemic lows in early 2021 to a 20-year high in September always looked like a safe bet once the market caught the Fed’s interest rate eye.
The dollar’s rally appears to be coming to an end amid lingering signs of deflation. Futures point to more modest rate hikes and a “tail rate” below 5% by mid-year, followed by rate cuts of almost half a basis point in the year’s second half.
Taken alone, this would reduce costs by more than 10% over a period longer than the last three months.
But this is not just a Fed story. Everything in the world is against the dollar.
Gas Producing Recession
In October, Japan unexpectedly intervened in its currency, stabilizing the falling yen. However, this happened last month when the Bank of Japan gradually eased its ultra-loose monetary policy for the first time. Further tightening has seen the yen gain nearly 20% in just over two months, and December’s policy shift is unlikely to be a one-off.
The euro rallied after the European Central Bank sounded more hawkish amid double-digit inflation in the eurozone late last year. It has since accelerated to a three-month gain of about 14%, thanks to a less severe winter. High natural gas storage fragmentation pushed up European gas costs. Many hoped this would trigger a recession, prompting some to reconsider the downturn as blackouts and rationing appear to have been averted.
Demand in China should have a strong recovery this year after China abruptly abandoned its strict and economically damaging “zero coronavirus” policy last month following popular outrage, with the yuan up about 10% from last year’s lows.
Trade forecasts at the start of the year seemed cautious about the significance of the future activity. However, current events have prompted many global banks to rethink their view of the dollar this year.
