Dollar’s Best Start In Decade Falters Before Key Inflation Data

(Bloomberg) -- The US dollar pulled back from the strongest rally at the start of a year in more than a decade as speculators piled into bets against the currency, convinced that cooling inflation will allow the Federal Reserve to start cutting interest rates this year.

The Bloomberg dollar spot index had rallied 1% during the first four days of the year, driving it to the biggest first-week gain since 2011, according to data compiled by Bloomberg. 

But it retreated for a second straight day Monday along with US Treasury yields, which had drifted up after falling sharply during the last two months of 2023 on mounting speculation the central bank will start easing monetary policy sharply this year. Those wagers face a key test with the release of the monthly consumer-price index on Thursday and data on producer prices Friday.

“The Fed’s rate cut pricing is being re-assessed and market remains sensitive to hawkish data surprises,” wrote Charu Chanana, market strategist at Saxo Markets, in a Monday note. “This could open the doors for a tactical USD recovery this week although a structural downtrend persists with March rate cut still remaining a high probability.” 

Read more: Bond Traders Seize on 4% Yields, Confident Fed Rate Cuts Coming

The dollar’s advance last week marked only a slight rebound from its steep drop since the onset of the Treasury rally in November. The index closed down 0.2% Monday, while Treasuries rallied across the curve. 

The currency’s trajectory will hinge heavily on whether traders have overestimated how much the Fed will cut interest rates this year. Right now, the futures market is pricing in that the central bank may cut its benchmark by as much as 1.5 percentage points in 2024, with the first move coming as soon as March.

Positioning data released by the Commodity Futures Trading Commission Friday showed that non-commercial traders — a group that includes hedge funds, asset managers and other speculative market players — upped their short bets on the dollar to the highest since late August. 

“If yields still head higher and equities still fall then USD could continue to gain on both fronts,” said Tom Fitzpatrick, managing director of global markets insights at R.J. O’Brien & Associates. “If we move lower from here that would be less USD supportive.”

(Updated to reflect closing level for Bloomberg Dollar Spot Index)

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