The dollar had its biggest single-day loss in over a year.
A lower-than-expected inflation report sent the dollar tumbling as markets now expect no further interest rate increases from the Fed.
The October Consumer Price Index (CPI) showed that prices at the retail level were unchanged from September, and annualized inflation dropped to 3.2%.
Bond markets rallied strongly (yields went lower) and the dollar (DXY) dropped by 1.5% in FX markets, its biggest one-day loss since November 10, 2022. Fed Funds futures, which had been pricing in at least one more rate increase, were repriced to show a 0% chance of further increases, with the possibility of rate cuts by late spring 2024.
It now appears central banks have managed to subdue global inflation, which seems to confirm a recent Goldman Sachs assessment that “The hard part is over.” The latest reading on eurozone inflation showed the consumer price index, which measures how fast prices are rising in the 20-member euro area, stood at 2.9% in October, dropping from 4.3% the month before and below economists’ expectations for a reading of 3.3%.
The UK reported that consumer prices were 4.6% higher in October than a year earlier, a drop from the 6.7% rate of inflation recorded in September and the slowest increase since October 2021. These numbers indicate that inflation remains above the shared target level of 2%, but the overall trend is moving in the right direction.
Most economists believe that the peak in interest rates has occurred, and global stock and bond markets have reacted sharply to the upside. The dollar has pulled back by almost 3% from its October high, and many economists believe that the greenback is destined to continue its current downward trend. The dollar has been generally overvalued against most major currencies, so a broad-based reversion to the mean is a strong possibility. The Economist’s Big Mac Index shows 46 currencies currently undervalued against the dollar and only 7 overvalued.
With central banks on hold, and six weeks left in the year, the most likely scenario appears that DXY will trade in a range between 106 and 103 (104.4 is the price as of this writing). Forex markets are traditionally quiet during the year-end period, and a pause in central bank interest rate activity may give currencies a reason to remain close to current levels through the end of 2023.
Potential drivers of Forex movement at year-end
- Economic conditions remain weak in Europe and the UK. Europe’s economy contracted by 0.1% during the third quarter and Great Britain showed zero growth during the same time. The US has experienced continuing growth during that period, so the dollar could benefit from the relative strength of the American economy.
- Japan continues to keep interest rates at record lows. The yen remains mired near its weakest levels against the dollar and other currencies If USDJPY breaks above 152, the technical picture points to a move to 158-160. Conversely, if the Bank of Japan decides to defend the yen through FX market intervention it could move higher against the dollar.
- Growth continues in emerging market economies. Emerging markets have experienced strong growth this year, and though not included in DXY, their currencies could regain some of the ground lost to the dollar in the past 2 years. A handful of countries have also benefited from changes in global supply chains, as many businesses look to shift some manufacturing away from China. The countries that have proven to be best positioned to replace China have been Mexico, Vietnam, Taiwan, and India.
Even if FX markets remain relatively stable for the near term, changing economic conditions will most likely contribute to a volatile environment in 2024. Now is a good time to do a comprehensive FX risk assessment to be prepared for movement next year.
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