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Dollar index collapses after dovish Fed

Traders sold the greenback after the latest Fed's decision, with the dollar index remaining in a bearish trend.

The US dollar index, tracking the strength of the US dollar against six major peers, declined to new cycle lows as Wednesday’s Fed decision sunk the greenback.

The Fed increased interest rates by 0.25% (25 basis points) and acknowledged recent efforts in bringing inflation down. However, investors took a dovish hint from Fed Chair Jerome Powell’s statement that “the disinflationary process has begun” in the world’s largest economy, despite the fact that he also indicated that interest rates would continue to rise and that rate cuts were not coming.

The rate hike cycle is over

The markets, however, appeared to interpret this as a lead that the central bank was near to achieving its peak interest rate during this cycle of rate hikes, and anticipation for a likely dovish shift by the Federal Reserve in the second half of the year increased.

While it is still predicted that the central bank would raise rates by another 25 basis points in March, the markets forecast that the Fed will then declare a pause in further rate rises.

“(Powell) said that rates are going to have to be restrictive for some time, but that doesn’t dissuade the market from saying some time might be six months, rather than two years,” said Ray Attrill, head of FX strategy at National Australia Bank

ING observed that the Fed funds rate had surpassed the core PCE inflation, a “key indicator” that the Fed had aimed to attain. As a result, the investment bank anticipates a sharper inflation decline over the next few months. For example, in December, the US core PCE price index stood at 4.4%, whereas the Fed’s target rate is now 4.75%.

Bloomberg stated that traders in interest rate swaps appear to be pricing in the probability of an interest rate cut of at least 50 basis points in the second half of the year.

US macro data deteriorate further

In addition, the DXY bears were encouraged by the mixed US data, as the ISM Manufacturing PMI dipped to its lowest level since June 2020, with a reading of 47.4 for January compared to 48.0 predicted and 48.4 before. Moreover, the ADP Employment Change decreased to a one-year low, with the most recent result of 106K compared to the market projection of 178K and the upwardly revised prior figure of 253K.

In contrast, JOLTS Job Openings increased to 11.01 million in December, above the average estimate of 10.25 million and the previous reading of 10.44 million.

The dollar index broke to new cycle lows below 101.30, confirming the bearish trend. Moreover, it remains within a large bearish channel, likely sliding further lower within the channel in the near future.

Dollar index daily chart

Dollar index daily chart, source: author´s analysis, tradingview.com

 

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