News & Analysis

Since the Federal Reserve’s December meeting, the DXY index has fallen by 1.5% despite data released over the same timeframe for December showing the unemployment rate falling below 4% and inflation data rising to a near 40-year high. This can be explained by a few factors. Firstly, eurozone bond yields have largely kept pace with the move in 10-year Treasury yields, which have stalled at the 1.8% level and continue to trade at a substantial discount to the Fed’s neutral rate estimate of 2.5%. Secondly, global risk appetite has improved since the turn of the year as concerns over the impact of Omicron fade. Coupled with an improved near-term growth outlook, the improvement in risk appetite has not only helped procyclical currencies but has also aided the rise in back-end eurozone bond yields, with the 10-year bund threatening to trade in positive territory. Looking ahead, further CPI and jobs reports are required to derive a firmer outlook for Fed policy and to trigger the next trend for the dollar. However, given inflation is likely to take some time to come down towards levels more palatable for the Fed and market, while the unemployment rate should remain on track towards the Fed’s forecast of 3.4% in Q4 2022, we expect incoming data to be supportive of a rate hike in March, with further hikes of 25bps increments likely to follow in both Q2 and Q3.

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Author: Simon Harvey, Senior FX Market Analyst

 

 

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