On Wednesday, the US dollar faced its second consecutive session of decline, indicating a phase of consolidation following a significant surge. This surge had been triggered by robust economic data from the United States and Federal Reserve officials' cautious stance regarding anticipated future cuts to interest rates.
Just the previous Monday, the dollar had surged to nearly a three-month high against the euro. This surge was a result of market expectations being dashed regarding a potential interest rate cut by the Federal Reserve in March.
However, from Tuesday onwards, the currency markets stabilized, and the EUR/USD exchange rate began to recover after experiencing notable declines.
Simultaneously, the yields on Treasury bonds, which often bolster the attractiveness of the dollar by drawing in foreign investments, also experienced a decline.
Despite the market's reluctance to fully embrace a bullish stance towards the dollar due to expected interest rate cuts later in the year, likely starting as early as May, recent fluctuations in currency values were likely driven by a combination of unexpectedly strong employment data from the United States, hawkish comments from Federal Reserve Chair Jerome Powell, and technical factors.
The dollar's resilience was further put to the test by the successful auction of new three-year Treasury bonds. This auction provided some relief from the recent high yields, indirectly impacting the strength of the currency.
In Europe, a significant decline in industrial production in the eurozone's largest economy did not seem to affect the euro significantly. This lack of impact was due to ongoing issues in Germany being well known to investors and thus already factored into market expectations.
Currently, investors are estimating an 18.5% likelihood of an interest rate cut by the Federal Reserve in March, compared to 14.5% on Monday. This estimation is according to the FedWatch tool from CME Group. At the beginning of the year, the probability stood at 68.1%.
The shift in market expectations regarding Federal Reserve policy, indicates a delicate balance between economic data, particularly inflation, and the timing of potential interest rate adjustments.
In the eurozone, while there has been a monthly increase in core inflation, there is also a year-on-year downward trend. This suggests a continued trend of disinflation.
Consequently, it is anticipated that this trajectory, combined with a slowdown in economic growth, will prompt the European Central Bank to commence interest rate cuts in the early stages of the second quarter, slightly ahead of the Federal Reserve.
Analysts emphasize that the short-term prospects for the EUR/USD exchange rate are closely linked to movements in the US dollar.
Additionally, they underscore that the timing and pace of interest rate adjustments by the European Central Bank relative to the Federal Reserve will depend significantly on upcoming economic data, which will play a crucial role in shaping the spread differentials between EUR/USD and the trajectory of the euro.
08.02.2024
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