The US dollar is trading choppy as rates and data weigh on the outlook

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The U.S. dollar is holding near one-year lows in the latest sign of uncertainty gripping Wall Street traders as they brace for the Federal Reserve’s looming interest rate decision.

The U.S. dollar index, which measures the greenback against a basket of six rival currencies, has fallen 3 percent since early August, leaving it hovering just above August lows, which were the weakest point since more than a year.

The dollar is sensitive to interest rate expectations as well as forecasts of the health of the US economy. It has fallen in recent weeks as weakening US data cemented bets that the Fed will loosen monetary policy for the first time since 2020 on Wednesday at the end of the central bank’s September meeting.

Putting more pressure on the greenback, traders have raised expectations in recent days for a 0.5 percentage point rate cut – double the size of a more traditional 0.25 percentage point cut that markets had previously priced in . Any such reduction would hurt US borrowing. costs fall from their current range of 5.25% to 5.5%, a 23-year high.

“Two things helped push the dollar lower: bets on Fed trades and the long dollar position, to begin with, which got squeezed,” said Mark McCormick, global head of FX and EM strategy at TD Securities, referring to the reduction in discounting traders. their bets on a rising US currency.

At the same time, appreciation in other major currencies has put downward pressure on the dollar, with the yen strengthening from 140 yen against the greenback this week for the first time since last July. The Japanese currency’s advance underscores the widening divergence between traders’ expectations of US and Japanese monetary policy, with the Fed expected to cut borrowing costs just as the Bank of Japan begins raising its own benchmark interest rate.

The dollar’s recent slide contrasted with a sharp rise in U.S. stocks, with the benchmark S&P 500 hitting a fresh intraday record on Tuesday, highlighting the ongoing divide among investors across asset classes over the outlook for the world’s largest economy.

The dynamics suggest that the dollar is focused solely on the fate of the US economy, neglecting the larger and more recent declines in China and Europe, which could ultimately drive global cash into the United States as foreign investors prefer better-performing US stocks and traditional safe havens such as the dollar and US Treasuries.

“The dollar is priced in for a U.S.-only slowdown,” McCormick said. “The dollar ignores what’s happening in China and what’s happening in the eurozone. Just because US stocks have underperformed for two months doesn’t mean there’s a better place to put your money: China and Europe are underperforming.”

Strategists also noted that the U.S. economy, unlike peers such as Japan, is not particularly export-based, meaning limited implications for U.S. companies with international operations due to the dollar’s recent weakness.

“We are too big and too insular an economy to be affected by the kind of moves in the dollar that we have seen so far,” said Ajay Rajadhyaksha, global head of research at Barclays.

All this suggests to Karl Schamotta, chief market strategist at Corpoay, the global payments and currency risk management firm, that the dollar is poised for a bigger move soon.

He pointed to a historical trend in currency trading called the “dollar smile,” a dynamic that illustrates the exceptional role of the U.S. currency in financial markets: It traditionally performs well both when the U.S. economy is booming and outperforms peers. and when the global economy is in recession and investors seek the protection of the US currency.

However, strategists said dollar prices may change soon.

“We are at the bottom of the smile right now. Global anticipated growth gaps narrowed. The US has lost momentum but is still doing relatively well,” Schamotta said. “There is an overcrowded trade against the dollar.”

Schamotta pointed to data, including a report on Tuesday morning that showed U.S. retail sales unexpectedly rose in August, a sign of steady consumer spending. He also pointed to the Atlanta Fed’s GDP indicator, which monitors real-time expectations for US growth. It currently shows that US GDP is expected to grow by 3% year-on-year in the third quarter.

“Numbers like retail sales and the Atlanta Fed Nowcast tell us that the US economy is still on a strong footing despite a slowdown. The only area of ​​weakness is a labor market that has corrected from overheated levels during the pandemic,” Schamotta said.