The dollar hits its lowest level of the year as traders brace for rate cuts

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The dollar hit its lowest level since the beginning of the year on Tuesday as investors braced for the Federal Reserve to start cutting interest rates and the August selloff that spooked markets faded.

The U.S. currency has fallen 2.2 percent against a basket of rivals this month — back to a level not seen since the first day of trading in January — as investors expect the U.S. central bank to cut rates next month.

The weaker greenback comes as the S&P 500 has recouped nearly all of its early August losses following a weak US jobs report and fears of an impending recession. Since then, calmer markets and more durable economic data have pushed investors back into “risky” assets.

“The market is looking for a soft landing and Fed rate cuts. . . which is negative for the dollar,” said Athanasios Vamvakidis, head of G10 currency strategy at Bank of America.

Investors are now looking ahead to a much-anticipated speech by Fed Chairman Jay Powell at the Jackson Hole Symposium on Friday, when he is expected to hint at the way forward for US interest rates.

Markets are pricing in three- to four-quarter-point cuts in Fed interest rates by the end of the year after strong retail sales figures restored confidence that an imminent recession will be averted. Traders rushed to set prices closer to five cuts this year after the weak jobs report.

Vamvakidis added that strong consumer spending, combined with optimism that the Fed will continue to deliver multiple rate cuts this year, was “good for risk sentiment” but not for the dollar because “the US currency is still overvalued.”

The dollar’s drop comes after it gained 4.4% in the first half of the year as the resilience of the US economy surprised investors who had expected more than six-quarters of a point in 2024 at the start of the year.

But Citi’s index of changes in U.S. data indicated as of late June that U.S. economic growth had slowed faster than that of other advanced economies compared to last year.

Since then, the dollar’s weakness has picked up pace. Citi said its hedge fund clients have been consistent sellers of US dollars since August 7 as risk appetite has recovered. The bank’s US dollar position indicator is currently the most bearish since May 2021.

“We have penciled in a mild recession for the US – the economy is definitely slowing and converging with other countries,” said Jane Foley, head of foreign exchange at Rabobank.

She added that the euro – the greenback’s biggest rival – had been “really resilient” in rising 3% against the dollar since the start of July, despite weak German manufacturing and slowing Chinese demand.

The dollar’s decline was fueled by an abandonment of popular “transactions,” in which investors borrowed yen to finance the purchase of higher-yielding dollars, which pushed the Japanese currency up 7 percent against the greenback in the past month.

Bets against the yen hit their most extreme level since 2007 last month, according to data from the U.S. Commodity Futures Trading Commission, but have eased sharply in recent weeks and tipped long last week for the first time since 2001.

“Dollar positioning has moved flat, but is nowhere near extended – now the question for the rest of the year is: do you want to get rid of the dollar?” said Chris Turner, head of research at ING.

State Street, one of the world’s largest custodian banks, said asset managers have swung from very positive sentiment on the dollar to neutral over the past two years and are still comfortably above neutral despite hitting the highest lowest level since April.

“The outlook for the US dollar is yet to fully pivot and may not happen until we get a clearer line of sight on the pace and depth of the Fed’s easing cycle,” said Michael Metcalfe, head of global macro strategy at State Street.