Why There Could Be Trouble Ahead for the Greenback

  • The dollar slipped around 1% this quarter on the prospect the Federal Reserve may be close to ending interest-rate increases.
  • Analysts are warning that the greenback’s losses could snowball over the rest of 2023.
  • Here’s why there could be trouble ahead for the currency, one of last year’s biggest winners.

The dollar slipped this quarter after notching its biggest annual gain since 2015 last year – and analysts are warning its recent struggles could be a sign of things to come.

The US Dollar Index – which tracks the greenback against six other currencies, including the euro and the Japanese yen – has slipped 1.1% over the past three months, after jumping more than 8% last year. The gauge has slumped more than 10% from a record high reached in September.

While the greenback’s setback this quarter may not seem big, some experts believe the buck’s losses will snowball during the rest of 2023 – and there’s two main reasons for that.

Interest rates

First, markets think the Federal Reserve will soon halt its interest-rate increases to soothe investors’ nerves about the health of the US’s under-fire regional banks. Almost 50% of traders think the central bank will refrain from lifting borrowing costs at its next meeting in early May, according to CME Group’s Fedwatch tool.

Such expectations are already weighing on the greenback and could hurt it further – because when interest rates stop rising, foreign investors seeking higher yields have less incentive to buy the currency.

“Nowhere have we seen interest-rate expectations pared back as much as the US, not among major central banks anyway,” OANDA analyst Craig Erlam told Insider. “There is clearly concern about what continuing the pace of tightening could do and what damage has already been done.”

“That change in interest-rate expectations has driven yields much lower which has, in turn, hit the dollar and if they don’t bounce back, it could do more,” he added.

Economic outlook

Second, the dollar’s trend is also seen as a reflection of the US economy’s health – and analysts are starting to warn that a late-2023 recession could be looming.

HSBC strategists said earlier this week that they’re expecting the dollar to slip further in the second half of the year as the economy feels the full effect of the Fed’s tightening and spending levels start to fall.

“Slowing US growth and peak rates should cause the US dollar to start trending down again,” they said in a research note Wednesday, adding that they expect to see the bulk of those declines between the start of the third quarter and the end of the year.

So while the dollar has wrapped up a quarter that was marked by widespread financial turmoil with modest declines, a combination of potential Fed easing and an expected economic slump might mean its losses only deepen from here.

Read more: Brace for an extended period of dollar weakness as the US economy is set to slow and the Fed will end rate hikes, HSBC says

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