The U.S. dollar recovered some of its losses against the euro on Tuesday on the heels of hawkish remarks by several Federal Reserve policymakers. The comments helped the greenback stabilize after heading for a 7-month low against its European counterpart.
The dollar’s recent slide has been sparked by doubts among market participants that the Fed will have to raise interest rates beyond 5% to curb inflation. These doubts have been fueled by data showing a slowdown in wage growth despite solid job gains in December, as well as a decrease in services activity.
Consequently, investors now estimate interest rates to peak just below 5% by June, before starting to decline in the second half of the year. This is despite JPMorgan CEO Jamie Dimon, one of the sharpest minds on Wall Street, urging the central bank today to raise interest rates beyond 5%.
Fed Reiterates Its Message but the Market Is Not Listening
A number of Fed officials, including Atlanta Fed Bank President Raphael Bostic and San Francisco Fed President Mary Daly, still think interest rates should remain elevated, contributing to their uncertain outlook.
“We are just going to have to hold our resolve,” Bostic told the Atlanta Rotary Club on Monday. When quizzed by the moderator how long he saw rates above 5%, Bostic replied: “Three words: a long time.”
“I am not a pivot guy. I think we should pause and hold there, and let the policy work.”
Valentin Marinov, head of G-10 FX research and strategy at Credit Agricole, said the mix remains “positive enough for the Fed” to keep raising interest rates.
“As such, I would think that any downward correction in the USD could be a shallow one, with investors using USD dips to position ahead of Powell and CPI next week,” he added.
The focus on speeches by senior Fed officials will remain elevated as investors prepare to hear from the chairman Jerome Powell, in a bid to gain more insight into the central bank’s monetary policy plans.
Market’s Bets on Pivot Increase After Jobs Report
The greenback saw the biggest decline in over three weeks after the U.S. jobs data raised hopes for smaller interest rate hikes going forward. Fresh data showed slower-than-expected wage growth and a major drop in U.S. services activity, pushing the Bloomberg Dollar Spot Index to the lowest point since mid-December.
Wells Fargo strategist Erik Nelson thinks the job data was robust in terms of employment numbers, but “the lack of another hot wages print likely keeps USD on the back foot for now.” That said, the analyst expects the greenback to continue trending downward for the following month.
The report showed that the U.S. added new jobs at a solid rate in December 2022, reducing the unemployment rate to the pre-pandemic low of 3.5% amid a tight labor market. The employment report also showed household employment rose by as many as 717,000 jobs last month, suggesting that the battle against inflation is far from over.
The whopping increase comes after a string of declines in household employment, which raised speculations that nonfarm payrolls were overstating employment rate growth. Nonfarm payrolls rose by 223,000 jobs in December, the smallest increase in two years. According to economists, the current job growth in the U.S. is more than double the Fed’s target of 100,000.
Focus Shifts to CPI
The Fed policymakers already said that any potential monetary policy changes depend on the new inflation data, which is out on January 12. A potential 25 bps increase would mark a significant drop in the size of interest rate hikes by the Fed after delivering four consecutive 75-bps rate increases last year.
If the CPI print backs the inflation cooling seen in the new monthly jobs report, the central bank would have to take a 25-bps increase "more seriously and to move in that direction,” said Bostic.
"Eventually I want us to get to 25 basis point rate hikes. The specific timing of that is going to be a function of the data that comes in."
Similarly, San Francisco President Mary Daly said both 25 bps and 50 bps rate increases are “on the table” for the Fed policy two-day meeting on February 01. Both policymakers believe the Fed policy rate should increase to a range of 5-5.25% from the current 4.25-4.5% in order to curb inflation.
Achieving this in a gradual manner allows the central bank to respond appropriately to new information and factor in the delayed effects of elevated borrowing costs on the broader U.S. economy, Daly added.
The Fed’s previous policy meeting in December showed no signs of possible rate cuts in 2022, as opposed to current market expectations for the central bank to begin trimming rates by the second half of 2023. Given the relationship between the Fed’s interest rates and global currencies, the Fed’s 2023 policy wouldn’t just affect the USD, but the global currency market, including emerging markets as well.
Summary
After the most recent jobs report signaled a slowing wage growth, which has fueled bets on the Fed pivot, investors are now shifting their focus toward the upcoming CPI print, which is due this Thursday. A stronger-than-expected decline in inflation year-over-year and month-over-month could spark another rally in stocks and push the dollar toward fresh multi-month lows.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.
