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Currency markets: Dollar strength and euro's ECB challenge, January 25, 2024

Currency markets: Dollar strength and euro's ECB challenge

The dollar exchange rate has been consistently maintaining its position near a six-week high, caught within the confines of two significant moving averages. Investors are eagerly awaiting GDP data from the United States, seeking valuable insights into the potential trajectory of interest rates in the country.

Concurrently, the euro is experiencing a weakening trend ahead of the impending decision by the European Central Bank (ECB), scheduled for release in the early afternoon (London time).

The Dollar Index (DXY), a metric gauging the strength of the greenback against six major currencies in the Forex market, is showing marginal gains, reaching 103.35. It remains in close proximity to the six-week peak of 103.82 achieved earlier in the week.

Investors are adopting a cautious stance, consolidating their positions as they brace for the upcoming Federal Reserve (Fed) meeting set for the following week.

Turning attention to the current trading session, the initial GDP reading for the United States in the fourth quarter is anticipated to reveal a year-on-year growth of 2%, based on a Reuters survey. However, estimates vary, ranging from 0.8% to 2.8%. Even at the upper end of this spectrum, such a figure would signify a noticeable deceleration compared to the 4.9% growth observed in the July-September quarter.

Despite this, expectations are that the report will indicate the United States managed to steer clear of a recession in 2023. Furthermore, moderate inflation is projected for the last quarter, fueling speculations of potential interest rate cuts in the first half of 2024.

The dollar index has observed a 2% uptick this month, prompting investors to significantly scale back their bets on early and substantial interest rate cuts by the Fed. This shift in sentiment comes in response to opposition from central bankers and a series of data releases underscoring the resilience of the U.S. economy.

Current market assessments indicate a 43% probability of rate cuts in March, according to the CME FedWatch tool, representing a notable decrease from the 88% probability recorded a month ago. Additionally, investors are estimating a total of 134 basis points in cuts for the year, as opposed to the 160 basis points projected at the close of 2023.

This week's data calendar for the U.S. also includes the release of the Federal Reserve's favored inflation metric, Personal Consumption Expenditures (PCE) data, scheduled for Friday.

Looking ahead to the following week, widespread expectations suggest that the Fed will maintain its existing monetary policy. However, market participants will scrutinize comments from Fed Chairman Jerome Powell for insights into whether the U.S. central bank is contemplating a reduction in interest rates.

The euro is currently displaying a slight weakening trend, recently trading at 1.0877 dollars before the ECB meeting. Analysts are confident that the ECB will keep interest rates unchanged, directing attention towards the potential strength of officials' efforts to counter expectations of substantial rate cuts. Market evaluations are currently indicating a projected 130 basis points in rate cuts by the ECB for the year.

While the ECB concluded its swiftest cycle of interest rate hikes in September, the central bank is resolute in asserting that any discussions about reversing this trend would be premature. This stance is grounded in the belief that inflationary pressures have not fully subsided, and crucial wage negotiations are still underway.


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