USD forecast: Dollar strengthens on Fed’s hawkish pause

Greenback bolstered by Fed as FX markets wait for decisions in Europe

The U.S. dollar index (USDX), which tracks the greenback’s performance against a basket of six major currencies, recovered some ground and surpassed the 105 mark after the Federal Reserve (Fed) signaled on Wednesday that a rate hike might still be on the table. While the central bank maintained the target range for the federal funds rate at 5.25%-5.5%, the released projections in the dot-plot suggested the likelihood of one more rate increase later this year, followed by just two cuts in 2024.

"This wasn't a 'pause,' it was a 'skip,'" Karl Schamotta, chief market strategist at Corpay in Toronto, told Reuters.

"With the economy performing better than expected and inflation pressures remaining persistent, Fed officials chose to maintain a hawkishly data-contingent bias in this afternoon's statement and dot plot," Schamotta said.

The index recorded its ninth consecutive weekly gain last week, marking its longest winning streak in nearly ten years, as enduring U.S. growth has fueled a dollar rebound.

The euro (EUR/USD) saw a 0.2% drop in value following the Fed announcement, falling below $1.07. The rate was also negatively affected by the European Central Bank's decision last week to raise rates by 25 basis points, reaching new multi-year highs. The ECB also signaled that it had likely completed its cycle of tightening.

The British pound (GBP/USD) extended its decline to the $1.23 mark, reaching its lowest level since the end of May. This downward trend is attributed to investors revising their expectations for future rate hikes by the Bank of England, primarily in response to lower-than-anticipated inflation data.

The Japanese yen (USD/JPY) depreciated to below 148 per dollar after the Fed meeting, marking its lowest point since early November. This decline is attributed to market expectations that the Bank of Japan will maintain its key short-term interest rate at -0.1% on Friday.

US Dollar forecast: USD registers gains as markets await decisions in Europe

The FX market responded to the Federal Reserve's hawkish pause by pushing the dollar slightly higher across the board. While the market's reaction has been relatively subdued thus far, the Fed's latest update could potentially lead to increased pressure on commodity-linked currencies, as per a comment from Dutch bank ING.

It's possible that the relatively mild response in the FX markets is influenced by the abundance of central bank meetings scheduled in Europe for Thursday. These meetings are expected to result in 25 basis point interest rate hikes in Switzerland, Norway, Sweden, and perhaps even the United Kingdom.

The Purchasing Managers’ Index (PMI) — a critical indicator of economic trends in the manufacturing and services sectors — for the Eurozone is due out on Friday, which will also likely have an impact on EUR/USD.

The bank’s longer-term projections are bearish on the dollar. ING’s EUR/USD forecast, last updated on August 22, saw the currency pair trading at a potential $1.15 throughout the final quarter of the year, going on to rise to $1.18 in Q1 and Q2 2024. Notably, ING is yet to update its baseline forecasts in September.

ING’S GBP/USD exchange rate forecast projected a potential average of $1.31 throughout Q4 2023, which could then rise to $1.33 in Q1 2024 and $1.34 in Q2 2024.

The EUR/USD forecast from Australian bank Westpac, last updated on September 15, saw the pair trading at $1.10 in December 2023, $1.11 in March 2024, and $1.12 in June 2024.

The bank’s pound to dollar forecast had the pair at $1.27 in December 2023, $1.28 in March 2024 and $1.29 In June 2024.

Economic data aggregator TradingEconomics was bullish on the dollar in its most recent USD forecast, projecting the DXY index to possibly trade at 106.73 by the end of this quarter. The platform’s 12-month dollar forecast estimated the index to trade at a potential 111.05 by September 2024.

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