Dollar down as markets assess likelihood of Fed rate cuts next year 

The U.S. dollar saw a decline on Friday, as traders weighed new data that showed inflation was easing, fostering expectations that interest rates had reached their peak and central banks — particularly the U.S. Federal Reserve (Fed) — might soon initiate rate cuts. 

The DXY dollar index, a gauge of the U.S. currency’s strength against six major counterparts, showed a 0.13% decrease at 103.37. This comes after the DXY index posted its weakest monthly performance in a year in November, despite an overnight surge of 0.6%. 

Thursday's data revealed a moderate rise in U.S. consumer spending in October, accompanied by the smallest annual increase in inflation in over two and a half years. The eagerly anticipated Personal Consumption Expenditures (PCE) price index indicated a 3% rise in October compared to the previous year, moderating from a three-month streak of 3.4% readings. However, it still exceeded the Federal Reserve's 2% target. 

Ryan Brandham, head of global capital markets for North America at Validus Risk Management, told Reuters correspondent Ankur Banerjee on Friday: 

"While the 3% level remains too high to declare victory on inflation, it marks a new low for the series that will likely please the Fed and alleviate any pressure to implement further hikes. It remains to be seen if getting from 3% to 2% will be easy, or if inflation will remain sticky in 2024." 

U.S. interest rates: Fed hints at end of hikes, markets pricing in December pause 

Federal Reserve policymakers indicated on Thursday that the era of interest rate hikes in the U.S. is likely over but kept the possibility of further tightening if progress on inflation stalls. Markets.com Chief Market Analyst Neil Wilson surveyed commentary by Federal Reserve officials on his morning notes on Thursday: 

“Fed policymakers are making noises like they think they are done. Bostic sounding more cautious, says inflation to trend lower, economic activity to slow in the coming months. Mester said ‘Monetary policy is in a good place for policymakers to assess incoming information on the economy and financial conditions.’ Barkin was a tad less certain: ‘I'm still in the 'looking to be convinced' category, rather than the 'convinced' category.” Still – it means the bar to a hike is still very high and the question is how long”. 

Market indicators show a 97% likelihood of the Fed maintaining its current stance in the December meeting, according to the CME FedWatch tool. There is also a 46% chance of a rate cut in March next year, up from 27% the previous week. 

Investors are now turning their attention to remarks from Fed Chair Jerome Powell later on Friday, anticipating every word to glean insights into the rate outlook. 

Carol Kong, currency strategist at Commonwealth Bank of Australia, told Reuters: 

"We expect Powell to reiterate the possibility of further tightening and dampen expectations of rate cuts. Further loosening of financial conditions may undermine the FOMC’s efforts to tame inflation pressures. That said, we do not expect the FOMC to tighten policy again." 

USD forecast: Scotiabank says December typically weak month for the dollar 

In his USD forecast on November 30, Scotiabank Chief FX Strategist Shaun Osborne wrote that there was not much scope for a significant dollar recovery:  

“The big dollar has recovered some ground overall so far [on Thursday], reflecting modestly higher US Treasury yields and weaker Eurozone data. That does not mean there is much scope for a significant USD recovery, however. Broader trends remain bearish and December is typically a weak month for the USD broadly (average return of around -0.9% in the December month over the last 25 years).  

Supposedly USD-negative month-end rebalancing flows have yet to show up but US data reports today may refresh USD-bearishness. Data are expected to reflect a softening labour market (rising claims), slower spending and weaker core inflation via the PCE deflator (3.5% YoY expected versus 3.7% in September).” 

At the time of writing, the DXY index was close to 0.20% down the day, trading around the 103.30 area, as per MarketWatch data. The euro to dollar exchange rate was up 0.19% at $1.0909, while the pound to dollar rate saw sterling gain 0.13% against the greenback, with GBPUSD trading at $1.2643.