(Bloomberg) – A stronger dollar is wreaking havoc in foreign exchange markets as traders prepare for the Federal Reserve to continue aggressively raising interest rates.
Over the past week, the pound fell above $1.14 for the first time since 1985, the Australian dollar hit a two-year low against the dollar, and the Chinese yuan fell to its lowest level since 2020, breaking the 7 per dollar mark.
Meanwhile, officials in Japan have indicated that they may be preparing to intervene in the market to prevent the yen – which is hovering near a 24-year low – from weakening further. The Euro slipped back below parity despite the massive ECB rate hike last week.
Traders are betting that the Fed will have to act decisively after a higher-than-expected inflation reading this week. They fully priced the third consecutive 75 basis point from Wednesday’s meeting and see a small opportunity for a larger 100 basis point move, the largest increase since 1984.
“The dollar’s call is really a call for inflation in the US,” Bank of America (NYSE:) strategists including Claudio Perón wrote in a note to clients. “Assuming the Fed remains committed to fighting inflation but also wants to avoid a hard landing, we expect the dollar to start weakening only when US inflation is on a clear downward trajectory.”
Inflation surprise puts burden on Fed to brake even harder
The Fed’s aggressive stance and the dollar’s role as a haven asset stand out against the backdrop of easing policy in China and Japan, and continuing concerns about growth in Europe due to the ongoing energy crisis. Commodity currencies were also hit, as traders factored in the risks of a global central bank tightening consumer demand.
“In such an environment, risk sentiment is struggling to recover and this is just another factor delaying any correction in the dollar,” ING Bank NV strategist Francesco Pesol wrote in a note to clients. “We see the dollar stay on solid ground in the FOMC announcement on Wednesday.”
Although the strategists at Goldman Sachs & Co (NYSE:) LLC including Dominic Wilson is not their base case, they calculated that the Fed’s tougher stance, which pushes the unemployment rate to 5%, could see another 4% increase. in dollars on a trade-weighted basis.
“Policy makers have made clear that they want to see inflation on a sustainable downward trajectory, which I interpret as at least several months of lower core inflation,” said Joachim Fels, managing director at Pacific Investment Management. The path may remain out of reach for some time, especially in the United States.”
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