US dollar drops to three-week low as traders weigh a Fed pivot

A gauge of the dollar’s strength fell to a three-week low as traders bet the Federal Reserve will temper the pace of its rate hikes amid signs the world’s biggest economy is starting to slow

A gauge of the dollar’s strength fell to a three-week low as traders bet the Federal Reserve will temper the pace of its rate hikes amid signs the world’s biggest economy is starting to slow. The Bloomberg Dollar Spot Index fell as much as 0.9%, sliding along with benchmark Treasury yields for a second day. While a 75-basis-point hike next week is fully priced, traders only see a 50% chance of an increase of that size in December, down from 80% last week. The repricing is benefiting the euro and the pound, with the common currency advancing past parity with the US dollar for the first time since September 20. Sterling jumped as much 1.3% to $1.1620, the highest level in more than a month. A slew of US data on manufacturing, home prices and consumer confidence have all fallen short of economist estimates, underscoring the toll of Fed tightening. Meanwhile, Federal Reserve officials have sounded a more cautious note, with San Francisco Fed President Mary Daly saying last week that policy makers should start planning for a reduction in the size of interest-rate increases. “We are probably on the last leg of USD strength,” said Themistoklis Fiotakis, head of FX research at Barclays Bank in an interview on Bloomberg Television yesterday. “It’s pretty clear that a lot of the components of the US economy are starting show signs of peaking, be it wage growth, inflation growth or whether that is the housing market.” Still, investors have been burnt more than once this year trying to predict when the Fed will adopt a less aggressive stance. “This is not the Fed pivot you are looking for,” Danske Bank FX strategist Lars Merklin wrote in a note. “Recent macroeconomic data points point towards inflation being very much still alive.” For now though, with many investors still positioned for more dollar gains, the market is at risk of a squeeze. Bullish greenback bets are around double the average over the last five years, according to Bloomberg CFTC non-commercial futures. The dollar’s slide is also being compounded as bearish sentiment toward the pound and the euro shift. UK assets rallied after former chancellor of the exchequer Rishi Sunak was appointed prime minister, signalling an end to a planned expansive fiscal policy under Liz Truss that had plunged markets into turmoil. The euro also is strengthening following a decline in natural gas prices which should improve the eurozone’s terms of trade position, according to ING Group NV strategist Chris Turner. A break of parity “could trigger quite a sharp short squeeze to $1.02,” he added. The brighter outlook for the common currency is manifesting in the options market, with one-week risk reversals for the euro-dollar pair trading at their least bearish levels since February. Hedge funds have cut their euro-short exposure to the lowest since June, according to CFTC data.