Dollar Flirts with New One-Year High
The US dollar index briefly reached a fresh one-year high on Thursday before pulling back sharply. This retreat came as little surprise, given the dollar had entered overbought territory, as indicated by the 14-day relative strength index surpassing 70. Even so, the index has climbed more than 6% over seven weeks, marking its most robust performance over such a period since 2022. Renewed risk aversion on Friday lent further support to the safe-haven dollar, while equity markets faltered after Jerome Powell hinted that the Federal Reserve sees no urgency to lower interest rates and expects PCE inflation to rise.
This week’s surge in the dollar was partly fuelled by President-elect Donald Trump’s hawkish cabinet appointments and the Republicans retaining control of the House, delivering Trump a political trifecta that heightens prospects for his policy agenda. Economic momentum had already shifted in favour of the US, prompting another hawkish reassessment of the Fed’s rate-cutting trajectory, which benefits the dollar via both fiscal-monetary and trade policy channels. Although expectations for sustained US growth into 2025 and Trump’s policies may outweigh seasonal dollar weakness through the year’s end, uncertainty remains significant. The critical issue now is the scale and pace of forthcoming policy changes.
On the data front, Wednesday’s CPI figures were complemented by PPI data signalling inflationary pressures in segments of the economy, which could constrain the Fed’s easing cycle. Core goods prices recorded their largest increase since February, further supporting projections for a rate cut in December. Overnight swaps reflect a 46% likelihood of this, with only two rate cuts anticipated over the next five Fed meetings.
ECB Rate Cut Fully Priced In
The euro has suffered five consecutive daily declines, falling to the mid-$1.05 range—the lowest level since October 2023. Minutes from the European Central Bank’s latest meeting strongly indicated policymakers favour further interest rate cuts, potentially as soon as December. Markets have priced in a 100% probability of policy easing. As inflation concerns fade, growth risks have become the dominant concern. Trump’s election, the prospect of tariff wars, and instability in Germany’s governing coalition have added to the challenges facing European policymakers.
The situation worsened in September, with industrial production recording its second-largest monthly drop this year, declining by 2%. Manufacturing production has shown annual growth in only one month since the start of 2023, highlighting the European industry’s struggles. Lower interest rates in 2024 are likely to be welcomed, but the euro faces continued downward pressure. Without a clear catalyst for recovery, bearish sentiment towards the currency is expected to persist.
UK Growth Stagnates Through Summer
The pound briefly rebounded from a four-month low near $1.26 to reach $1.27 before relinquishing some of its gains following disappointing UK GDP data. The economy contracted unexpectedly in September, resulting in just 0.1% growth for the third quarter.
The dominant services sector expanded by 0.1%, while construction grew by 0.8%. However, industrial production fell by 0.2%, painting a lacklustre picture for the new Labour government, which had pledged to achieve annual growth of 2.5%, the fastest in the G7. Compounding Britain’s economic challenges is the spectre of a new wave of protectionism following the US election. Nonetheless, the direct impact on the UK is expected to be minimal, given the US maintained a goods trade surplus of $10.5bn with Britain in 2023, with the UK accounting for just 2.1% of US goods imports.
Sterling faces an uphill battle to recover to $1.30 against the dollar, as tighter US monetary policy, driven by the inflationary effects of tariffs, continues to weigh on the currency. Additionally, sterling’s pro-cyclical nature makes it particularly sensitive to market volatility. With equities and cryptocurrencies losing momentum, safe-haven demand is likely to bolster the dollar, keeping the pound under pressure in the near term.
