The US dollar steadied on Monday after US inflation data showed a modest rise last month, helping ease some concerns about the pace of US interest rate cuts next year. The data came to confirm that inflationary pressures remain under control, reinforcing the view that the Fed may slow down in cutting interest rates, despite earlier market expectations that these cuts will accelerate.
The dollar index, which measures the greenback’s performance against six other major currencies, settled at 107.78 on Monday, near a two-year high of 108.54 on Friday. This stability in the value of the dollar reflects the cautious equilibrium that markets are trying to achieve in light of the changing economic outlook, while at the same time reflecting the extent to which the impact of US interest policy on the global economy may reach in the coming months.
Meanwhile, the Japanese yen settled near the 156-yen mark to the dollar, prompting speculation that the Bank of Japan could intervene in the markets to curb the currency’s decline. This stability has added to tensions in financial markets, with many expecting Japanese authorities to take new measures to keep the currency stable.
On the other hand, investor sentiment rose after the US Congress succeeded in avoiding a federal government shutdown, by passing spending legislation early on Saturday. Last week, the Federal Reserve surprised markets when it announced its expectations of a calculated rate cut in the future. This sent yields on US Treasuries higher, supporting the dollar against other major currencies. This trend has had a significant impact on global economies, especially in emerging markets, which often find themselves under pressure when the dollar rises and US yields increase.
The impact of inflation on expectations of a rate cut
Inflation is one of the key factors on which the central bank relies to determine its monetary policy, including setting interest rates. When inflation rises, it becomes necessary for the central bank to take action to contain it, often by increasing interest rates. Conversely, if inflation is low or in decline, the central bank may cut interest rates to stimulate economic growth. But the impact of inflation on expectations of interest rate cuts is not always clear or linear, but depends on several complex factors that overlap with each other.
The impact of inflation on interest policy depends largely on the type and strength of inflation. If inflation is caused by strong demand in the economy, i.e. an increase in consumer and investment spending, this may put pressure on prices and require the central bank to intervene to raise interest rates to curb this excessive demand. Conversely, if inflation is caused by episodic factors, such as rising raw material prices or disruptions in supply chains, the central bank may choose to postpone any changes in interest rates until these pressures subside.
In the case of moderate inflation, market expectations about a rate cut may remain affected by the need to support economic growth. When inflation is stable or slightly high, this may indicate that the economy is still in a recovery phase or that it is facing certain pressures that require technical intervention. On the other hand, if economic data shows that inflation has risen significantly and rapidly, the central bank may reconsider plans to cut interest rates.
The impact of dollar stability on investors
The stability of the US dollar is one of the main factors influencing the decisions of investors around the world. The US dollar is not only the world’s primary reserve currency, it also plays a pivotal role in global financial markets. Thus, its stability or volatility significantly affects investment strategies, as investors rely on it to assess potential risks and returns.
First, when the US dollar is stable, it boosts confidence in financial markets and encourages investors to make more positive investment decisions. Currency stability means that exchange rate fluctuations between the dollar and other currencies remain within a reasonable range, reducing the risks associated with international exchanges and cross-border trade transactions. This stability encourages foreign investors to invest in US assets, whether stocks, bonds, or real estate, because they feel confident that exchange rate fluctuations will not significantly affect the value of their investments.
On the other hand, the stability of the dollar contributes to the strength of the US economy, prompting investors to consider the US market as a safe place to invest. A strong dollar is usually associated with a strong and stable economy, boosting investor confidence in US assets. This is especially important in periods of economic uncertainty, such as financial crises or recessions, where investors prefer to hold secured and stable assets such as the US dollar. When the dollar is stable, too, investors have a greater ability to value assets in foreign currencies. For example, if global markets experience significant exchange rate fluctuations, companies and investors may have difficulty estimating their profits or losses resulting from changes in the value of their local currencies against the dollar.
