How effective will the Fed’s actions be on the outlook for the dollar?

Yields on US government bonds stagnated. At the time of publication, the yield on US 10-year bonds was 1.849%, down from the local 2-year high of 1.897% hit on Wednesday. Along with falling government bond yields, the dollar is also falling. Thus, the DXY dollar index, which reflects the value of the dollar against a basket of 6 major currencies, was at the time of publication of this article close to the 95.49 mark, remaining in the area below the recent range between the 96.94 and 95.54 levels.

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Investors are pricing in the outlook for the dollar (in line with upcoming Fed rate hikes) and the threat of accelerating US inflation. Earlier this month, the US Department of Labor Statistics reported that consumer prices rose 7.0% (on an annualized basis) in December after rising 6.8% in November. This corresponds to highs nearly 40 years ago. Core inflation (excluding food and energy) increased in December by 5.5% (in annual terms). Thus, inflation has exceeded the Fed’s 2% target for several months in a row, and its growth at such a pace is forcing investors to set up long positions on the dollar: they fear that the Fed will be slow to take political monetary tightening measures. Market participants have already forecast 3 Fed rate hikes this year, and it looks like some of them think that won’t be enough to curb soaring US inflation.

On the other hand, if the Fed starts raising interest rates at an accelerated pace, the higher cost of financing could negatively affect demand and economic growth, while inflation will remain elevated for some time. So brake it quickly, most likely, will not work. In response to such a scenario, the dollar might be inclined to weaken. Recall that the next meeting of the US Federal Reserve’s Open Market Operations Committee is scheduled to be held on January 25-26.