Dollar hits 3-month low after official Fed signals interest rates may start falling

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The dollar hit a three-month low on Tuesday and U.S. Treasury yields fell as investors became increasingly confident that the Federal Reserve will begin cutting interest rates in mid-2024.

The U.S. currency fell 0.5 percent against a basket of six currencies and was at its lowest level since mid-August.

The decline accelerated after Christopher Waller, one of the Fed’s most hawkish policymakers, signaled that interest rates were unlikely to rise further and could be cut if inflation continued to slow.

“I am increasingly confident that policymakers are currently well positioned to slow the economy and bring inflation back to normal levels [the Fed’s target of] 2 percent,” Waller told the American Enterprise Institute think tank.

“If we see that disinflation continues for several more months – I don’t know how long that will last, three months, four months, five months…” . . Then you could start lowering the key interest rate just because inflation is lower.”

He added: “There’s just no reason to say you’d be retained [rates] For example, it is very high and inflation is back to target.”

Inflation fell more than expected to 3.2 percent last month, compared with a peak of 9.1 percent in June last year.

Fed Chairman Jay Powell said this month that the central bank was “not at all” considering cutting interest rates.

But investors are now betting that the Fed is likely to cut interest rates as early as May – a month earlier than suggested in pricing last week.

The 10-year U.S. Treasury yield, which moves inversely to price, fell 0.04 percentage points to 4.35 percent on Tuesday. The decline brings yields to levels last seen before the Fed’s September meeting, when warnings that interest rates would remain higher for longer sparked a global bond downturn.

The two-year yield, which depends heavily on interest rate expectations, fell 0.09 percentage points to 4.77 percent, the lowest level since mid-August.

The dollar is now on track for its worst monthly performance in a year, having lost 3.6 percent since the start of November.

Line chart of the DXY index showing the dollar falling to a three-month low as investors bet on interest rate cuts

Waller’s comments also come in the final days before the Fed limits public communications ahead of its final policy meeting of the year.

After eleven consecutive interest rate hikes after March 2022, the central bank has kept its key interest rate stable at a 22-year high of 5.25 percent to 5.5 percent since July.

The Fed is widely expected to leave interest rates unchanged at its December meeting, and Waller said U.S. growth appears to be moderating, “as I had hoped, supporting further progress on inflation.” Recent data suggests that consumer spending is slowing, along with business activity and labor demand.

In a question-and-answer session, Waller said he expects fourth-quarter growth to moderate significantly to around 1 percent to 2 percent after posting faster-than-expected annual growth of 4.9 percent between June and September was.

However, he noted that it is still too early to say definitively that the Fed has ended the rate hike cycle as the labor market remains “quite tight” and job creation is outpacing supply.

He added that looser financial conditions – partly a result of moves in the bond market – also suggested caution is warranted as lower yields could offset the impact of the Fed’s rate hikes to some extent.

Contrary to Waller’s comments, Michelle Bowman, his fellow Fed governor, said Tuesday she still believes the central bank will likely need to raise interest rates further to bring inflation down “in a timely manner.”

She argued that variables such as the strength of consumer spending and supply-side factors could keep inflation higher than expected. She also warned that the “neutral interest rate” – the level that neither stimulates nor depresses the economy – may have increased over time in the wake of the Covid-19 pandemic.

“We should keep in mind the historical lessons and risks associated with prematurely declaring victory in the fight against inflation, including the risk that inflation will rise to levels above our 2 percent target without further policy tightening could level off,” Bowman said.