The US dollar’s status as one of the few reliable safe havens for investors amid this year’s market chaos began to crumble during the fourth quarter, even as the greenback made its biggest annual gain since 2015.
For much of the year, the strong dollar was blamed for weighing on equities as a more expensive currency hurt export earnings and corporate earnings, while higher government bonds made bonds increasingly attractive relative to equities.
But something changed for the dollar around the start of the fourth quarter. Central banks in Europe and – more recently – Japan have pursued a more aggressive monetary policy, signaling their intention to close the gap with higher US yields created by the Federal Reserve. This helped drive their currency upwards.
At the same time, investors in the US were betting that the Fed’s rate hike campaign was nearing its end.
This resulted in the euro EURUSD,
up about 8.8% against the dollar, the biggest quarterly gain since 2010, according to Dow Jones Market Data.
Meanwhile, the ICE US Dollar Index DXY,
a measure of the dollar’s strength against a basket of six major currencies, is on track to fall 7.7%, the largest quarterly decline since the second half of 2010, Dow Jones Market Data shows. the yen USDJPY,
and British Pound GBPUSD,
also strengthened along with many emerging market currencies, and in the space of one quarter, the dollar’s gains nearly halved since the start of the year.
Despite this, the dollar index was still up 7.9% this year, its biggest calendar year increase since 2015, when it rose 9.3% amid the eurozone debt crisis fueling fears that Greeks might leave the euro .
Just before the start of the fourth quarter, the dollar index reached 114.11 on Sept. 27, the highest settlement level of the year, according to data from FactSet. At the time, the popular gauge of the value of the dollar was up about 19% this year.
Currency analysts attribute this shift to two things. One is the perception that inflation in the US is starting to cool, easing pressure on the Fed to be so aggressive with its rate hikes.
“…[I]Inflation and growth are declining in the US and if that continues, additional rate hikes by the Fed will become less likely,” said Bipan Rai, global head of FX Strategy at CIBC, in a research note released earlier this quarter.
At the same time, the European Central Bank has hinted that it is far from done raising rates, while investors remain hopeful that the Fed’s first rate cut could happen in 2023, even as the latest dot plot forecast suggested of the Fed that won the first cut. arrive early next year.
The ECB raised key rates by 50 basis points two weeks ago, just after the Fed made a similar hike, but unlike the Fed, ECB chief Christine Lagarde and other senior policymakers have indicated they are far from done with their rate hikes.
“…[T]The Fed is nearing the end of its rate hike campaign, and according to the markets, even closer than it currently thinks. Second, the ECB appears to be in contention for the title of ‘Most Aggressive Major Global Central Bank’ as members of the Governing Council of the ECB have behaved aggressively,” analysts at Sevens Report Research said in a recent post.
Heading into 2023, many on Wall Street expect the dollar to weaken further.
However, currency analysts made this caveat: whatever happens to the greenback may ultimately depend on the Fed. If, as expected, the Fed maximizes Fed Funds rates to around 5%, the dollar may move lower, but if stubborn inflation and a strong US job market force the Fed to be even more aggressive with its monetary policy, then the dollar will be able to get a new impulse.
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