A labor market that refuses to cool, inflation that remains stable and an economy that continues to expand have lowered expectations that the Federal Reserve will cut interest rates much this year and bolstered the US dollar.
Since the end of September, the US dollar index, which measures the dollar against a basket of foreign currencies, has risen 3.4% as inflation and jobs data have lowered the odds for multiple rate cuts in the last two Fed meetings of 2024.
The dollar has surged against its foreign peers since late September after the Fed cut rates for the first time since cutting them to near zero at the start of the pandemic in 2020. The rising probability that the Fed's first rate cut this year could prove to be its last as the domestic economy continues to thrive will likely bolster the dollar further.
"The US dollar has already strengthened this month on the back of the view that the US economy remains more resilient that expected," said Jane Foley, head of foreign exchange strategy at Rabobank. "If the jobs market remains relatively robust and the Fed cuts rates less than expected, US dollar strength would almost certainly be extended."
As of Oct. 21, about one-third of the futures market was expecting the Fed to cut its benchmark rate by just 25 basis points by the end of December, meaning the Fed would have at least one meeting where officials would not cut at all, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market. A month earlier, the majority of the market was betting that the Fed would cut at least 75 bps before the end of this year. Now, no one is betting on cuts of that size, according to the tool.
The ongoing US dollar rally would get "turbocharged" if the Fed's monetary policy easing cycle is more moderate than any other foreign central bank's cutting cycle, said Elias Haddad, a senior markets strategist with Brown Brothers Harriman.
The dollar tends to rise with interest rates and tighter monetary conditions as investors move to government bonds and other dollar-denominated securities. A stronger dollar bolsters US spending power abroad but can dent overseas profits for US-based companies.
As expectations for the start of the Fed's rate cut cycle ramped up this summer, the dollar lost ground to all its G10 peers. But since the first cut at the Fed's September meeting, the dollar has gained on all of them. If the Fed continues to appear less dovish the dollar will likely continue to rally against these foreign currencies, Foley with Rabobank said.
The Norwegian krone and the Japanese yen could fare the worst if the Fed is slow to cut rates, said Derek Halpenny, head of research for global markets at MUFG.
Outside of rates, Halpenny said he sees the US election as the primary other issue driving the dollar. Some of the rally in the dollar is likely due to expectations of a Donald Trump victory in November since many of his policy plans are likely to curb any Fed easing plans.
"Tariffs, fiscal expansion and mass deportations are all inflationary and that will see the Fed doing less and drive the dollar stronger initially at least," Halpenny said. "I am not sure if over the medium term Trump will be good for the dollar but initially through the remainder of 2024 and over the first half of 2025 it probably will."