US dollar weakness expected to continue as inflation cools

The currency slumps to a 14-month low as markets stay confident of an end to Fed tightening

Unrecognizable mature man holding US Dollar bills. Getty Images
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The recent decline in the US dollar is expected to persist after the greenback fell to its lowest level in more than a year on Wednesday as consumer prices in the world’s largest economy slowed in June, experts said.

It also suggested that a quarter-point increase by the Fed this month is still considered very likely, but the odds of an additional increase were trimmed after the release of latest data.

The US Dollar Index – a measure of the value of the dollar against a weighted basket of major currencies – is down nearly 3.2 per cent since the start of the year and about 7.7 per cent over the past year.

Headline annual consumer price inflation fell to 3 per cent, down from 4 per cent in May, and has been dropping since hitting a peak at 9.1 per cent in June of last a year earlier. The US Federal Reserve aims to bring inflation down to its 2 per cent target and has raised interest rates combined 500 basis points over the past 16 months, their highest since 2007, shortly before the start of the 2008 global financial crisis.

On an annual basis, US core CPI – which economists view as the better indicator of underlying inflation – advanced 4.8 per cent, lower than market expectations for a 5 per cent increase. That was also the smallest annual increase in more than two years.

“The data reinforced our view that recent dollar weakness will persist,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.

“We, therefore, recommend investors with the Japanese yen, euro, British pound or Swiss franc as their home currency to strengthen their home bias. We also expect gold, which benefits from a weaker dollar, to reach new all-time highs.”

As the Fed raised rates to fight inflation last year, overseas investors piled in seeking a higher rate of return, driving the dollar to a 20-year high in September.

The greenback is now weakening as US interest rates near a peak. Easing inflation backs the case for the US central bank to wrap up its rate-hike campaign in the coming months.

However, there are arguments in favour of a stronger dollar. The Fed may keep rates higher for longer if inflation does not fall back within its target. The world’s reserve currency also tends to strengthen amid risk aversion and worsening recession fears may spur renewed strength in the dollar.

“The sell-off in the US dollar accelerates post-CPI, with the dollar index approaching the 100 level with big and steady steps,” said Ipek Ozkardeskaya, senior analyst at Swissquote Bank.

“This is good news for inflation in the rest of the world, because the softer the US dollar, the softer the energy and raw material prices negotiated in terms of US dollars. In the same way the dollar appreciation fuelled inflation globally, its depreciation could help ease it as well.”

The slowdown in inflation during the first half of this year will be sufficient for the Fed to continue keeping interest rates steady in the future and wait for the effects of previous monetary tightening on the economy after an additional 25-basis-point increase in the upcoming Fed meeting, scheduled for July 26, said Rania Goule, market analyst at multi-asset broker

“However, interest-rate cuts are still far-fetched from our perspective until the Fed reaches its inflation target of at least 2 per cent or 3 per cent, which would provide some modest support for the dollar in the long term,” she added.

The release of the US CPI data showed a strong and broad-based slowdown in price pressure, weighing on the US dollar and US bond yields while triggering a relief rally in the gold and silver markets, according to Carsten Menke, head of next generation research at Julius Baer.

The slowdown in underlying inflation momentum brings the Fed a big step closer to declaring victory in its fight against inflation and paves the way for one last final rate increase and the end of an extraordinarily steep tightening cycle at the next FOMC meeting on July 25 and 26, said David Kohl, chief economist with Julius Baer.

“In our view, confidence has increased that the Fed will deliver one more hike and then be done,” he added.

Updated: July 13, 2023, 10:19 AM