Dollar strengthens for second consecutive week amidst resilient U.S. economy and diminished rate cut expectations

The dollar is poised for a second consecutive weekly advance, buoyed by indications of resilience in the U.S. economy. Traders, influenced by a more cautious stance on rate cuts by central bankers, are moderating their expectations for rapid and substantial declines in interest rates.

Both the Australian and New Zealand dollars, sensitive to risk, are on track for their most significant weekly gains since November and July, with increases of 1.6% and 2.3%, respectively. Market sentiment now suggests a 57% likelihood of a U.S. rate cut in March, down from 75% a week ago.

Westpac’s Head of Foreign Exchange Strategy, Richard Franulovich, emphasized that recent U.S. activity data and central bank communications signal that market expectations for 2024 rate cuts are overly aggressive in terms of timing and magnitude. This realization, coupled with renewed turbulence in China’s property and financial markets, has led to a resurgence of the dollar.

For the week, the dollar index has risen by 0.9% to 103.4, with the yen experiencing the most significant decline, down 5% for the year. Factors contributing to the yen’s weakness include data showing Japan’s core inflation slowing to 2.3% in the year to December, the lowest annual pace since June 2022, and a deadly earthquake denting confidence in the Bank of Japan’s potential rate hike.

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In the Asia session, other currency movements have been relatively modest, resulting in the euro declining by 0.6% to $1.0884 for the week, and sterling decreasing by 0.4% to $1.2705. The Australian dollar received marginal support from stabilizing iron ore prices, rising 0.1% to $0.6578, while the New Zealand dollar remained shaky at $0.6099.

Recent robust U.S. labor market data, including a notable drop in weekly jobless claims to their lowest level in nearly 1-1/2 years, has increased pressure on expectations for market rate cuts. Two-year Treasury yields, indicative of short-term interest rate expectations, have risen by 22 basis points this week to 4.3587%.

In Europe, a hawkish tone from central bankers has tempered expectations for rate cuts, influencing the euro’s modest decline against the dollar. British inflation exceeding expectations has similarly curbed bets on Bank of England rate cuts, providing support to the pound.

Concerns about China’s property markets have unsettled investors, leading to significant declines in mainland shares and the currency, drawing state-bank intervention to stabilize it at an almost two-month low of 7.1999 per dollar.

Bitcoin has experienced a five-week low at $40,484, with traders taking profits after the U.S. approval of spot bitcoin exchange-traded funds. Despite investors pouring $1.9 billion into nine new bitcoin ETFs in their first three trading days, the inflows fell short of some aggressive estimates for day-one multi-billion inflows.