Dollar bounces back as US economy defies doubters

The dollar has rebounded from a 10-month low as investors push up their forecasts for US interest rates after signs of stubborn inflation and unexpectedly strong economic activity.

The world’s most important reserve currency rose to a 20-year high in September but tumbled 11.2 per cent over the following four months as US inflation declined from a multi-decade peak, allowing the Federal Reserve to slow the pace at which it raised interest rates towards the end of 2022. Tamer rate rises and the prospect of steady or even falling rates in 2023 removed one of the currency’s key supports.

However, February has begun with a flurry of economic data suggesting the world’s biggest economy remains in rude health, pushing the dollar back up by 3 per cent against a basket of six other leading currencies since the start of the month and erasing January’s decline.

The US last month added more than half a million jobs, almost triple the consensus forecast, while inflation fell to 6.4 per cent, a smaller decrease than expected.

“The inflation report has ruined markets’ nice little disinflationary plan,” said Florian Ielpo, multi-asset portfolio manager at Lombard Odier, with central banks likely to maintain their upward pressure on rates as a result.

Jordan Rochester, a foreign exchange strategist at Nomura, said February began “with everyone in the macroeconomic community assuming the dollar would sell off against the euro and the yen. Since then almost every single US data point has come in stronger than expected, and markets have slowly come around to what the Fed has been saying for a long time, that rates have further to go and will be kept on hold for a while.”

Benchmark US interest rates stand in a range of 4.5 per cent to 4.75 per cent. At the start of February, futures markets were pricing in a rates peak close to 4.9 per cent, with two cuts in the second half of the year taking borrowing costs to about 4.4 per cent heading into 2024.

Just over two weeks later, markets had shifted to predict a peak at 5.28 per cent, ending the year just above 5 per cent following a single cut.

Still, some investors doubt the dollar rally has much longer left to run. The haven currency is likely to continue to rise this quarter but “resume its downward trajectory as global growth and risk sentiment improve,” said analysts at UBS.