Dollar Gains Amid Reduced Rate-Cut Expectations and Escalating Red Sea Tensions

The Inspirer.

SINGAPORE – The dollar strengthened on Tuesday as investors scaled back expectations for near-term rate cuts by the U.S. Federal Reserve, influenced by hawkish comments from European Central Bank officials.

Simultaneously, concerns about potential attacks on ships in the Red Sea weighed on overall risk sentiment.

Against a basket of currencies, the dollar rose by 0.253 percent to 102.90, following a 0.2 percent gain overnight during subdued trading on Monday, which was a U.S. public holiday.

The euro declined by 0.3 percent to $1.09185, marking its steepest one-day percentage drop in two weeks. Sterling also slipped to $1.2681, down 0.36 percent on the day, moving away from its nearly five-month high of $1.2825 reached in late December.

Comments from European Central Bank officials, specifically pushing back against early rate cuts, cast a shadow on the global outlook for interest rates. “It’s too early to talk about cuts; inflation is too high,” stated ECB’s Joachim Nagel on Monday, emphasizing the importance of avoiding the mistake of lowering interest rates prematurely.

Money markets are pricing in 145 basis points worth of cuts to the ECB’s deposit rate this year, likely starting in April. “The hawkish ECB commentaries last night have fueled concerns that market pricing for the Fed rate path may also be aggressive,” said Charu Chanana, head of currency strategy at Saxo in Singapore. “Some safe-haven demand is also likely to be at play with Red Sea disruptions escalating.”

An official from Yemen’s Houthi movement announced on Monday the group’s intention to expand its targets in the Red Sea region to include U.S. ships, vowing to continue attacks after U.S. and British strikes on its sites in Yemen.

Investors are now awaiting comments from the Federal Reserve’s Christopher Waller, whose dovish turn in late November contributed to sending markets soaring in a year-end rally. Waller is scheduled to speak later on Tuesday.

Market expectations for a 25 basis points cut in March from the Fed have slightly decreased to a 70-percent chance, down from 77 percent a day earlier and 63 percent a week earlier, according to the CME FedWatch Tool. This highlights the shifting expectations regarding rate cuts.

However, traders are projecting cuts of over 160 bps this year, up from 140 bps of easing projected last week. Hamish Pepper, fixed income and currency strategist at Harbour Asset Management, noted, “We think the market may have got ahead of itself pricing almost seven 25 bp cuts from the Fed this year,” adding that the dollar is likely to find support if markets reassess easing expectations and push short-term interest rates higher.

The yield on 10-year Treasury notes increased by 5.3 basis points to 4.003 percent, while the two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, rose by 7.3 basis points to 4.211 percent.

The upcoming week includes reports on Chinese fourth-quarter growth and U.S. retail sales scheduled for Wednesday. Jobs and inflation data will be the focus for sterling traders, helping fine-tune their interest-rate models. Markets are currently pricing around 120 bps of rate cuts by the Bank of England in 2024, with the first one likely in May.

Meanwhile, the yen weakened by 0.20 percent to 146.07 per dollar after data showed Japan’s wholesale inflation was flat in December from a year ago, slowing for the 12th straight month. The data suggest that rises in consumer inflation will moderate in the coming months, alleviating pressure on the Bank of Japan (BOJ) to phase out its massive.