Weak U.S. economic data indicates a change in Fed policy
U.S. economic data released this week generally fell short of expectations, especially the slowdown in inflation, which strengthened market expectations for the Federal Reserve to end its aggressive monetary tightening cycle. The focus now shifts to when the Federal Reserve will start cutting interest rates. Markets are pricing in a mere 0.3% chance of another rate hike in December, compared with about 15% a week ago. According to the CME FedWatch tool, the probability that the Federal Reserve will begin to loosen monetary policy in March next year is 35%.
The decline in U.S. Treasury yields has been accompanied by a decline in the value of the dollar. The dollar fell nearly 0.6% against the yen this week, its worst weekly performance since July. Relative to the dollar, the euro and pound were also up more than 1.5% each, while the U.S. dollar index was expected to fall 1.3%.
Market reaction and currency dynamics
The euro was steady at $1.0851 and the pound last traded at $1.2412.
Sean Callow, senior currency strategist at Westpac Banking Corporation, said: "The market reaction to the U.S. Consumer Price Index (CPI) has been very strong, and even if the inflation misses expectations by a small margin, it is bad for the outlook for the dollar. News. This could set up a narrative that the market begins to discuss the December Federal Open Market Committee (FOMC) statement, not only that interest rates will remain unchanged, but also that there may be a shift to a more neutral stance.
Separate data this week showed U.S. retail sales fell for the first time in seven months in October, while the U.S. labor market showed signs of cooling as the number of Americans applying for unemployment benefits rose to the highest level in three months.
The yen last traded at 150.72 against the dollar, still just below the 150 threshold and not far from Monday's one-year low of 151.92.
While U.S. interest rates may have peaked, and market insiders believe the Bank of Japan (BOJ) is preparing the market for an end to negative rates, the wide gap between Japan's ultra-low interest rates and U.S. rates still puts pressure on the yen.
Callow said: "I think (the Bank of Japan) will remain cautious. Our view is that they won't adjust policy settings for a long time, so there won't be changes until deep into next year. If that is the case, then the U.S. dollar's yields may become less attractive, but we don't think it's enough to truly turn things around -- the gap between the two remains wide.
Elsewhere, the Australian and New Zealand dollars are also expected to gain 1.7% and 1.3% respectively this week, helped by the US dollar's slide.
The Australian dollar was last down 0.08% at $0.6466, showing little reaction to positive Australian employment data released in the previous session.
The New Zealand dollar fell 0.14% to $0.5963.
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