The US Dollar Struggles as Interest Rate Cuts Loom

The US Dollar Struggles as Interest Rate Cuts Loom

The US Dollar (USD) is facing challenges as it declines towards the 102.15 area, putting pressure on the 20-day Simple Moving Average (SMA). Despite gaining momentum last week, bulls are struggling to sustain their gains. With Monday’s calendar offering no significant events, investors are eagerly awaiting the release of the Consumer Price Index (CPI) figures from December on Wednesday.

In its latest meeting, the Federal Reserve (Fed) took on a dovish stance, expressing satisfaction with moderating inflation and projecting no rate hikes in 2024. The Fed also forecasted a 75 basis points easing. Market expectations are now pointing towards possible rate cuts in March and May, depending on the upcoming December CPI report. This dovish posture and the anticipation of rate cuts contribute to the weakening of the US dollar, as lower interest rates reduce the appeal for foreign investment.

The key data that investors are eagerly awaiting is the inflation figures for the last month of 2023. It is expected that the core measure will show a year-on-year increase of 3.8%. These figures will have a significant impact on the market and could further influence the direction of the US dollar.

The US dollar is also facing pressure due to the drop in US Treasury yields. The 2-year, 5-year, and 10-year yields have all experienced a decline. With the 2-year yield at 4.32%, the 5-year yield at 3.94%, and the 10-year yield at 3.98%, the US dollar is feeling the effects of the decrease in yields.

Looking at the indicators on the daily chart, there is a bearish outlook for the USD. The Relative Strength Index (RSI) is showing a negative slope in negative territory. This is supported by bearish sentiment indicated by the rising red bars of the Moving Average Convergence Divergence (MACD) indicator. The USD’s position above the 20-day SMA while below the 100 and 200-day SMAs suggests that selling pressure is outweighing buying pressure in the medium and long-term time frames, indicating dominance by the bears.

Monetary policy in the US is largely shaped by the Federal Reserve (Fed), which has two mandates: achieving price stability and fostering full employment. The Fed primarily uses interest rate adjustments to achieve these goals. When inflation rises above the Fed’s 2% target, it raises interest rates to increase borrowing costs and attract international investors to the US, resulting in a stronger USD. Conversely, when inflation falls below 2% or the unemployment rate is high, the Fed may lower interest rates to encourage borrowing, which weighs on the USD.

The Federal Reserve holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC consists of twelve Fed officials, including the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four regional Reserve Bank presidents who serve one-year terms on a rotating basis.

In extreme situations, the Federal Reserve may resort to Quantitative Easing (QE), a policy used to increase the flow of credit in a stuck financial system. QE involves the Fed printing more USD and using them to buy high-grade bonds from financial institutions. This policy weakens the US dollar. On the other hand, Quantitative Tightening (QT) is the reverse process of QE, where the Fed stops buying bonds and does not reinvest the principal from maturing bonds to purchase new ones. QT usually has a positive impact on the value of the USD.

As the US dollar struggles to hold onto its gains from the previous week, market focus shifts to the upcoming CPI figures for December. The dovish stance of the Federal Reserve and anticipation of rate cuts further weigh on the USD. Additionally, the drop in US Treasury yields adds pressure to the currency. The bearish indicators on the daily chart indicate that selling pressure is surpassing buying pressure, signaling the dominance of bears. The monetary policy decisions made by the Federal Reserve play a significant role in shaping the movement of the USD. The upcoming CPI figures will be crucial in determining the direction of the currency and the market’s response.

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