Why A Falling Dollar Signals ‘Markets Are In Wonderland’ Over Inflation And Fed
Why A Falling Dollar Signals ‘Markets Are In Wonderland’ Over Inflation And Fed
William Watts Thu, January 13,
The U.S. dollar is stumbling to begin 2022 even as investors pencil in a much more aggressive Federal Reserve response to persistent inflation. Here's why.
The U.S. dollar is offering up an early 2022 head scratcher: Why does the currency keep falling even as traders aggressively pencil in as many as four interest rate increases by the Federal Reserve this year as it scrambles to rein in red-hot inflation?
The ICE U.S. Dollar Index DXY, 0.08%, a measure of the currency against a basket of six major rivals, was down 0.1% on Thursday at 94.81, hitting a two-month low. The index is off 1% so far this week, leaving it with a loss of 1.2% since the start of the new year.
A more aggressive tightening of monetary policy, from a more “hawkish” central bank, would usually be expected to support a currency. The reaction may make more sense, however, if one looks at how little interest rates are expected to ultimately rise once the Fed begins the rate-hike cycle, said Kit Juckes, global macro strategist at Société Générale.
He noted that while traders have moved quickly to price in four rate increases this year, they still look for the fed-funds rate, currently in a range of 0% to 0.25%, to top out at no higher than 2%. That’s not realistic, but it may explain the recent performance not only of the dollar, but other assets as well.
“Markets are in wonderland,” he said, in a Thursday note.
U.S. stock-market investors are cheered by the prospect of a “terminal rate” of 2%, and ignoring a more hawkish Fed because the prospect of faster rate hikes reflects hopes the worst of the COVID-19 pandemic is over, he said.
A fed-funds rate topping out at 2% is a “Goldilocks” scenario — to the extreme, Juckes said, and it’s reflected in a reaction Wednesday to a 7% year-over-year rise in the December consumer-price index, a nearly 40-year high, that saw the S&P 500 SPX, -1.42% climb back within 2% of its all-time high and the Cboe Volatility Index VIX, 5.76% fall back hard.
Need to Know: Is it time to fight the Fed? This veteran strategist says the central bank won’t risk a 20% drop in house prices and a 30% slide in stocks.
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