Fed's Continued Hawkish Stance Amid Stickier-Than-Expected Inflation Rate: A Boon For US Dollar?

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The U.S. dollar has been benefitting from the Federal Reserve's hawkish stance, as the rising benchmark interest rates have resulted in an appreciation of the greenback with respect to other foreign currencies. The dollar index has risen by nearly 3.2% so far this year, reflecting its strength as the world's reserve currency. 

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Battle Against Inflation 

As the Federal Reserve's battle against inflation draws to a close, concerns regarding the dollar's strength have surfaced. However, while Fed Chair Jerome Powell has signaled three rate cuts for this year, experts predict the dovish trend to kick in during the second half of 2024 as the labor market remains resilient.  

Federal Reserve Governor Christopher Waller reiterated the delay in rate cuts signaled by Powell, claiming that the current market data "tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2 percent."

The consumer price index (CPI), the benchmark indicator for inflation, rose 3.2% year-over-year in February, significantly higher than the central bank's 2% annual inflation target. The job market has also remained strong, with nonfarm payrolls rising by 275,000 in February, surpassing the anticipated payroll growth of 198,000 as predicted by Dow Jones economists.  

Federal Funds Rate and the US Dollar 

An increase in the benchmark federal funds rate strengthens the dollar against other currencies, as the higher yields result in an inflow of foreign capital from investors who sell their respective foreign currencies in exchange for the dollar. 

The two-year Treasury yield rose by nearly 6 basis points to 4.63% on March 28, as investors expect the Fed to maintain its restrictive stance on the monetary policy. 

"The strength of the U.S. economy and resilience of the labor market mean the risk of waiting a little longer to ease policy is small and significantly lower than acting too soon and possibly squandering our progress on inflation," Wallace added in his statement released on March 27, adding, "I concluded then that we needed time to verify that the progress on inflation we saw in the second half of 2023 would continue, which meant there was no rush to begin cutting interest rates to normalize the stance of monetary policy." 

Nonetheless, according to the CME Group's FedWatch Tool, traders currently place a 60% probability of rate cuts in June. 

Will the Momentum Continue? 

Several nations have begun slashing benchmark interest rates as concerns regarding economic slowdown and incumbent recession woes pile in. The U.S. economy has remained surprisingly resilient despite growing macroeconomic challenges and geopolitical tensions, as evidenced by its strong consumer spending levels and thriving labor market. 

The real GDP of the U.S. is expected to rise by 2.3% on a seasonally adjusted annual basis in the first quarter of 2024, according to data released by the Federal Reserve Bank of Atlanta. This marks a 20 basis point increase from the previously predicted 2.1% increase. 

The Federal Reserve's dovish approach is expected to be less aggressive than other nations, as the European Central Bank foresees at least four rate cuts of 25 basis points each in fiscal 2024 alone. Moreover, the Swiss National Bank began implementing its rate-cut strategy by slashing its main policy rates by 0.25% earlier this month. These factors combined could allow the dollar to retain its momentum in the months to come. 

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