Dollar index at 2-week highs as markets look to Q1 rate cuts

Euro falls, dollar index at 2-week highs on expectations of interest rate cuts in Q1

On Wednesday, the U.S. dollar index reached a two-week peak, while the euro displayed weakness across various currencies, reflecting the growing market sentiment that the European Central Bank (ECB) may implement interest rate cuts as soon as March.

The euro declined by 0.2% against the dollar, hitting a three-week low of $1.0773. This downward trend in the euro was attributed to recalibrated rate expectations following lackluster economic data and cautious statements from central bank officials.

In addition to its dip against the dollar, the euro also marked a three-month low against the pound, a five-week low against the Japanese yen, and a 6-1/2 week low against the Swiss franc.

Niels Christensen, chief analyst at Nordea, told Reuters:

"The story in currency markets is mostly about a softer euro. Yesterday's comments from ECB's Schnabel supported the market view of early rate cuts."

Isabel Schnabel, an influential policymaker, said on Tuesday that further interest rate hikes might be taken off the table given a "remarkable" decline in inflation. Consequently, markets are now assigning a close to 85% chance of the ECB reducing interest rates at the March meeting, with nearly 150 basis points of cuts anticipated by the end of the next year.

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Central bank news: ECB, Fed and BoE to announce interest rate decisions next week

The upcoming week holds interest rate decisions from major central banks, with the ECB expected to maintain its rates at the current record high of 4%. The Federal Reserve (Fed) and the Bank of England (BoE) are also likely to keep rates steady the following week.

As the Federal Reserve enters a blackout period ahead of the December 12-13 meeting, traders are closely watching for updated projections on 2024 rate expectations. According to CME’s FedWatch tool, markets are currently assigning a 60% likelihood that the U.S. central bank will reduce rates in March, with at least 125 basis points of cuts priced in for next year.

In recent days, investors have been reevaluating the anticipated extent of U.S. interest rate cuts in the coming year, contributing to a rise in the value of the dollar.

Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management, told Reuters on Wednesday:

"Markets have gone a bit overboard with pricing in very aggressive path of rate cuts through next year. Our view is that Fed might hold off till the second quarter and even then the cuts would be a lot shallower than what the market would like.”

Mitra said there could be a snapback should the Fed drive home the message more forcefully that it is not about to cut rates anytime soon.

A Reuters poll of foreign exchange strategists suggests that the anticipated rate cuts by the Fed are expected to loosen the dollar's hold on other G10 currencies in the next year, potentially impacting the greenback's outlook negatively.

Euro to dollar forecast: ING says test of 1.07 may be possible if dollar stays bid

In an overview of forex markets on Wednesday, ING FX strategist Francesco Pesole wrote that the EUR to USD pair may test the 1.07 level before the weekend, provided the dollar index stays bid:

“A catalyst for an idiosyncratic euro rebound is not in sight, at least for today, when there are no scheduled European Central Bank speakers and the eurozone’s data calendar only includes the October retail sales – hardly ever a market mover in the region.

The big slump (7.3% YoY) in Germany’s factory orders for October (data released this morning) is likely to keep the negative euro narrative alive at the start of the European session. EUR/USD is now trading very close to the 1.0770 100-day MA support, and a break lower can further fuel the bearish momentum. A test of 1.0700 before the weekend is entirely possible if the dollar remains bid.”

The dollar index, which gauges the currency against six other major currencies, rose by 0.1% to 104.07, reaching a two-week high of 104.10 earlier in the day. The euro to dollar exchange rate stood at $1.0794, with the common currency shedding 0.07% of its value against the greenback on the day.

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