Dollar Nears Four-Week High as U.S. Inflation Data Dampen Hopes for Large Fed Rate Cut

The U.S. dollar traded near a four-week high against the euro on Thursday, bolstered by signs of persistent inflation in the U.S., which dampened expectations of a larger-than-expected interest rate cut by the Federal Reserve next week. Traders have scaled back their bets on a 50-basis point (bp) cut, now anticipating a smaller 25-bp reduction.

Meanwhile, attention turned to the European Central Bank (ECB), which is widely expected to implement a quarter-point rate cut later today. Investors will be keen to hear whether the ECB signals further rate reductions in the near future. The prospect of additional cuts has been a key factor for the euro, which has struggled to gain ground against the dollar amid tightening monetary policies on both sides of the Atlantic.

Dollar Gains Against Yen Amid Volatile Sessions

The dollar also strengthened against the yen, rebounding from a sharp decline in the previous session. On Wednesday, the greenback dropped as much as 1.24% against the yen, reaching its lowest level this year, before recovering its losses following the release of U.S. consumer price data. The dollar was trading 0.31% higher at 142.805 yen as of 0505 GMT on Thursday, after climbing as much as 0.41%.

The yen’s movement has been influenced by the Bank of Japan’s (BOJ) tightening stance. BOJ board member Junko Nakagawa reiterated on Wednesday that low real interest rates left room for additional rate hikes. On Thursday, another BOJ member, Naoki Tamura, a noted policy hawk, indicated that the market might be underestimating the pace of future rate increases. These remarks helped mitigate yen losses, although market volatility surrounding the yen has increased in recent weeks.

The dollar’s rebound against the yen, which touched a low of 140.71 on Wednesday, indicates a potential recovery toward the 145.50 level, according to Tony Sycamore, an analyst at IG. The dollar-yen pair often tracks U.S. long-term Treasury yields, which also bounced back after hitting a 15-month low of 3.605% on Wednesday, rising to 3.6646% in Thursday’s Asian trading session.

U.S. Inflation Data Shifts Market Expectations

The latest U.S. inflation figures, which showed the consumer price index (CPI) rising by 0.2% in August, matched July’s increase. However, the core CPI, which excludes volatile food and energy prices, increased by 0.3%, accelerating from a 0.2% rise in July. This stronger-than-expected reading has led traders to reduce the likelihood of a larger 50-bp rate cut by the Federal Reserve at its upcoming meeting. According to market pricing, there is now an 85% probability of a smaller 25-bp reduction.

Looking ahead, traders still expect 104 bps of rate cuts by the end of the year, suggesting a possible 50-bp reduction in either November or December. TD Securities analysts, including global FX strategist Jayati Bharadwaj, noted that recent signs of U.S. economic resilience have tempered market expectations for more aggressive rate cuts in 2024. “Dollar positioning is very clean, and it looks structurally cheap given the lingering macro, political, and geopolitical uncertainty,” they wrote, maintaining a bullish outlook on the dollar, particularly against the euro.

ECB Expected to Deliver Rate Cut

Markets are fully pricing in a quarter-point rate cut from the ECB, with an announcement expected later today. Policymakers have signaled their willingness to continue reducing rates following a similar cut in June. Investors will be watching closely for any hints on how soon the ECB might implement further rate reductions as the eurozone economy continues to face inflationary pressures and slowing growth.

As the dollar continues to gain strength, market participants are balancing inflationary signals, central bank policies, and geopolitical risks, all of which will shape the currency landscape in the coming months.