Dollar sinks as investors increase bets on slower Fed rate rises

The dollar sold off and Treasuries rallied on Thursday after a closely watched measure of inflation came in lower than expected and a speech from Jay Powell raised hopes that the Federal Reserve would soon slow its rate rises.

A measure of the dollar against half a dozen peers fell 1.2 per cent. The pound jumped 1.5 per cent to $1.224, with the euro rising 1.1 per cent and Japan’s yen rallying 2.1 per cent.

Thursday’s fall in the dollar is the latest sign of a shift in market expectations for the path of Fed rate rises — an issue that has dominated global markets this year.

“The market has taken the view that inflation is already history, and that the Fed will pivot pretty soon and that rate hikes will diminish from December onwards,” said Didier Rabattu, head of equities at Lombard Odier Investment Management.

The US currency surged throughout most of 2022 as the Fed raised interest rates more aggressively than most other central banks in a battle to tame inflation. However, it has fallen back since a better than expected inflation report last month fuelled hopes that the Fed would soon slow down the pace of increases.

Those hopes were reinforced in a speech by Fed chair Powell on Wednesday and fresh inflation data on Thursday.

The US core personal consumption expenditures index, the Fed’s preferred inflation gauge, rose 0.2 per cent in October from the previous month, according to data from the commerce department. Wall Street had expected an increase of 0.3 per cent.

A separate survey from the Institute for Supply Management showed cost pressures in the US’s manufacturing industry were cooling at the fastest pace since 2020.

“What we are seeing in the US is some of the serious drivers of inflation disappearing, the price of food, gas, property, all seem to have reached a peak,” Rabattu said.

Powell said at the Brookings Institution on Wednesday that “the time for moderating the pace of rate increases may come as soon as the December meeting”.

Line chart of Dollar index showing The dollar has fallen as inflation fears have ebbed

US government bonds also extended their gains after advancing in response to Powell’s speech. The yield on the benchmark 10-year note, which falls when prices rise, dropped 0.19 percentage points to 3.51 per cent, according to Tradeweb data.

Equity markets, however, were more muted. The S&P 500 slipped 0.1 per cent after posting its first back-to-back monthly advances since 2021. The Nasdaq Composite inched up 0.1 per cent, while Europe’s region-wide Stoxx 600 rose 0.9 per cent.

Trading in futures markets shows investors now expect the Fed to raise its main interest rate to a peak of about 4.9 per cent next year, from a forecast of 5 per cent at the start of this week and a high of 5.14 per cent in early November.

Investors expect rates will then fall back to 4.4 per cent by the end of 2023, despite Fed officials’ repeated assertions that rates will remain high for an extended period once they have peaked.