Greenback Hits 7-Month Low

The price of the US Dollar Index (DX) dropped to its lowest level since 2 January today, Tuesday, 20 August, at 101.85, as traders assess the probability of the FOMC members voting for a cut in interest rates in September 2024. Let’s explore the connection between rate cut expectations in the United States and the Dollar’s decline, and the outlook for the greenback:

US Dollar Under Pressure

The US Dollar Index, a measure of the US dollar's strength against a basket of six major currencies including the USD/EUR (EURUSD), the USD/JPY (USDJPY), the USD/GBP (USDGBP), the USD/CAD (USDCAD), the USD/SEK (USDSEK) and the USD/CHF (USDCHF), is on track for its second consecutive monthly decline, having already shed over 2% in August.

Accordingly, the EUR/USD pair strengthened significantly, reaching its highest level since 28 December at $1.108775. At the time of writing, it trades up 2.4% for the month, putting it on track for its best monthly performance since November. The GBP/USD pair increased to a one-month peak of $1.2998 yesterday on Monday, 19 August.

Moreover, the USD/JPY pair strengthened slightly at 146.50. This level is close to the nearly two-week high reached yesterday. Still, it remains below the seven-month peak of nearly 141.675 reached in early August during Nikkei’s largest loss since the 1987 Black Monday. (Source: CNBC)

US Rate Cuts on the Horizon

​​Some traders initially anticipated aggressive rate cuts in early August after a surprising jump in the July unemployment rate, as depicted by the Non-Farm Payroll (NFP), that ignited recession fears and sent shockwaves through global markets. 

However, trader sentiment has shifted since then. According to the CME Group’s FedWatch Tool, the probability of a 50-basis-point rate cut in its meeting occurring on 27-28 September has dwindled from 50% a week ago to 23%, while the odds of a 25-basis-point reduction now stands at 77%.

When the Fed decides to decrease its federal funds rate, it typically lowers interest rates across the economy. Consequently, investments in USD can become less attractive to foreign investors than assets in other currencies that might provide higher returns. 

This reduced interest in US assets can lead to a sell-off of dollar-denominated holdings, increasing the supply of dollars in the Forex market. As a result, the value of the US Dollar tends to weaken.

Why Are Traders Focusing on Powell’s Speech at Jackson Hole on Friday?

Whether or not Fed chair Jerome Powell hints that the Fed may reduce interest rates by 25 or 50 basis points during the FOMC September meeting will be a primary focus for traders following his address that will take place on Friday, 23 August, at Jackson Hole.

Some Fed officials, such as Mary Daly, the San Francisco Federal Reserve President, think it is time to adjust the US monetary policy. 

Neel Kashkari, the President of the Minneapolis Federal Reserve, believes that it is reasonable to address the possibility of lowering interest rates in September due to the growing likelihood of a weaker labour market. 

Former Chicago Fed President Charles Evans also thinks that the labour market could be weakening due to the increases in the unemployment rate, especially if the following job reports remain poor. 

Still, Powell may be hesitant to commit to specifics this week due to the fact that important economic data, especially regarding inflation and employment, are expected to be published before the Fed's meeting in September. 

Conclusion

The US Dollar's recent decline, reaching a 7-month low, is primarily driven by growing expectations of potential interest rate cuts by the Federal Reserve. As traders anticipate lower returns on US assets, they might be shifting their holdings towards other currencies, weakening the Dollar's value. While market sentiment leans towards a rate cut in September, the actual decision hinges on upcoming economic data. Traders are likely to be focused on Jerome Powell's speech at Jackson Hole for potential clues about the Fed's monetary policy trajectory.

Tomorrow (on Wednesday, 21 August) the FOMC minutes of the last Fed’s meeting will be published, also allowing traders to get additional insights into the reasoning behind the decision to keep interest rates unchanged during its July meeting.