US dollar continues to weaken against major currencies

Cooling inflation compounds the greenback's fall as markets anticipate that the Fed will back off from its current path of increasing interest rates

The US dollar has erased its gains against the euro since the start of the year. EPA

The US dollar's weakness continued in January, with the US Dollar Index — a measure of the value of the greenback against a weighted basket of major currencies — sliding to a seven-month low after peaking at a 20-year high last September.

The dollar's entire second-half rise in 2022 has now been erased, as markets position themselves in expectation of US Federal Reserve action and its direction on interest rate policies.

Since my last column, we had the US inflation report for December, which showed another run of cooling inflation readings.

Overall, year-on-year inflation came in at 6.5 per cent, down from 7.1 per cent in November, while core prices — excluding food and energy — came in at 5.7 per cent compared with November's reading of 6 per cent.

This compounded weakness in the greenback, as market participants increased bets that the Fed will back off from its current path of increasing interest rates.

During its last meeting, the Fed indicated that rates would exceed 5 per cent in 2023.

However, futures pricing now indicates that this level could top out between 4.75 per cent and 5 per cent.

The theme of divergence between markets and policy will continue in the lead up to the next Fed rate decision meeting, which concludes on February 1.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

While key Fed members have reiterated their commitment to the current path, upcoming US jobs data will be central to deciphering their views.

The central bank has long been cautious towards a hotter-than-expected US labour market and its implications on inflation.

Last week’s jobless claims — a weekly measure of the number of individuals filing for unemployment insurance — came in at 190,000, well below market expectations of 215,000.

While this still shows a rather robust US labour market, it is important to note that the data was released before Google's announcement on Friday that it would lay off 12,000 employees globally.

If we get a continued run of slower-than-expected hiring numbers, coupled with slowing wage growth, this will continue to stoke the divergence debate and weigh on the dollar's prospects.

Across the pond, the current bearish move in the dollar has benefitted the euro, which finds itself north of 1.09 levels for the first time since April last year.

Up more than 10 per cent in the past three months, the EUR/USD move continues to be exacerbated by fundamentals.

The optimism surrounding China’s move to end its zero-Covid policy continues to drive positive sentiment in Europe.

Coupled with falling energy prices and a rather hawkish European Central Bank, we continue to remain bullish on EUR/USD prospects in the short and medium term.

The US interest rate differential play also has been a factor in the euro's rally.

In theory, these should all combine to stoke further upside in the euro.

In the current rally, I see a further push towards 1.1150 levels in the common currency, while it needs to close above 1.0850 this week to confirm this level as a short-term support level.

Meanwhile, gold bulls have been rewarded by the weakening dollar.

The precious metal continues its four-week march since the turn of the new year, a period in which it has gained 11 per cent.

I expect another conclusive test in the channel between $1,970 and $2,000, with any further upsides highly unlikely.

On the economic calendar this week is the release of data for US gross domestic product, due out on Thursday at 5.30pm UAE time. Fourth-quarter GDP is expected to come in at 2.6 per cent.

Also due out on Thursday is the weekly US jobless data, with new claims expected to come in at 205,000.

The personal consumption expenditures price index — the Fed’s preferred measure of inflation — will be released on Friday.

Core PCE year on year for December is expected to be 4.4 per cent, below November's 4.7 per cent print. Expect a weaker print to keep the dollar anaemic through to the beginning of February.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers