The dollar has experienced a downward trend throughout 2023, resulting in its first yearly loss against the euro and a basket of currencies since 2020. The decline is attributed to expectations that the U.S. Federal Reserve will initiate rate cuts in the coming year as inflation moderates. As we enter 2024, questions arise regarding when the Fed will embark on the rate reduction journey and if it is to prevent over-tightening or due to a slowdown in U.S. economic growth. Additionally, there is a debate surrounding how much further the dollar will weaken.
The dollar has already weakened significantly in anticipation of future rate cuts by the Federal Reserve. According to Brad Bechtel, the global head of FX at Jefferies in New York, the market has adjusted its expectations and priced in aggressive cuts, leading to the dollar’s decline. This acceleration occurred after the Fed’s December policy meeting, which featured an unexpectedly dovish tone and a forecast of 75 basis points in rate reductions for 2024. The market is even projecting more aggressive cuts, with the first reduction likely to occur in March and a total of 158 basis points in cuts by the end of the year.
The Federal Reserve’s tone contrasts with that of other major central banks such as the European Central Bank (ECB) and the Bank of England (BoE). While the Fed is moving towards rate cuts, the ECB and the BoE have expressed intentions to hold rates higher for a longer duration. However, Bechtel believes that eventually, all three central banks will capitulate and implement rate cuts. The struggling European and British economies, coupled with fast-falling inflation, make it difficult for them to maintain their current stance. If all three central banks initiate rate cuts, it will be challenging for the dollar to weaken significantly.
The dollar’s performance against a basket of currencies reveals a slight increase of 0.13% to 101.32 on Friday, recovering from a five-month low of 100.61. However, its overall performance in 2023 is dire, with a 2.10% loss for the year and a 4.62% decline in the last quarter, marking its worst performance in a year. In contrast, the euro experienced a 0.19% dip to $1.1040, just below its five-month peak of $1.11395. Nonetheless, the euro is on track for a 3.04% gain this year, making it the first positive year since 2020. These trends can be linked to the market’s anticipation that the U.S. will cut rates earlier compared to the ECB’s potential slower pace of cuts. Additionally, positive risk appetite contributes to the dollar’s softness.
Sterling has seen a modest 0.08% rise to $1.2745 and is expected to end the year with a 5.39% gain, marking its best performance since 2017. The Japanese yen, on the other hand, is an outlier. The dollar is projected to achieve a remarkable 7.56% annual gain against the yen due to the Bank of Japan’s (BOJ) ultra-loose monetary policy stance. While market expectations hint at the BOJ exiting negative interest rates in 2024, the central bank has remained committed to its dovish line without providing clear indications of how such a scenario would unfold. Even if the BOJ raises rates into positive territory, they would still remain significantly lower than those in the United States, making the yen an expensive currency to possess.
The Swiss franc has been one of the best-performing currencies in 2023, resulting in the greenback’s worst drop against the currency since 2010, with an 8.99% loss. As for cryptocurrencies, Bitcoin experienced a 1.23% decline to $42,059 but is set to end the year with a remarkable 154% gain.
The dollar faces a challenging environment as it concludes 2023 with its first yearly loss against major currencies since 2020. The anticipation of rate cuts by the U.S. Federal Reserve has led to the dollar’s decline, while contrasting central bank policies and positive risk appetite further weaken the currency. Looking forward, the performance of other currencies like the euro, pound, yen, Swiss franc, and cryptocurrencies like Bitcoin will continue to shape the forex landscape in 2024.
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