Dollar sinks to yearly lows as markets eagerly await rate cuts

The dollar just tanked to its lowest level this year, hitting a point that hasn’t been seen since January. Investors are betting big that the Federal Reserve is about to start cutting interest rates, with many expecting it to happen as soon as next month. 

The American currency has dropped 2.2% against other major currencies this month, as the markets recover from the chaos that August brought with it. 

This decline comes as the S&P 500 has almost bounced back from the losses it took earlier in August, following a weak U.S. jobs report. 

Fear of a recession gripped the market, but those fears seem to be easing as more solid economic data emerges. 

Investors have started jumping back into riskier assets, thanks to the more optimistic outlook.

All eyes on the Fed

Now, everyone’s looking at Jay Powell, the Fed chair, as he’s set to give a big speech at the Jackson Hole symposium this Friday. Traders are hanging on every word, hoping he’ll give some hints about where U.S. interest rates are heading. 

The market is currently pricing in three or four quarter-point rate cuts by the end of the year. After strong retail sales figures came out, there’s been renewed confidence that a recession isn’t as close as everyone feared. 

Earlier in the month, after a soft jobs report, traders were even more pessimistic, pricing in nearly five cuts this year.

The dollar’s current decline is a sharp turnaround from the first half of the year when it actually gained 4.4%. Back then, the U.S. economy’s resilience caught investors off guard. They had been expecting more than six rate cuts in 2024. But now, things have changed. 

According to Citi’s U.S. data change index, the U.S. economy has been slowing down faster than other advanced economies since late June, which has only added to the dollar’s slump. 

Citi’s hedge fund clients have been consistently selling off U.S. dollars since August 7, as they gain confidence in riskier assets again.

A big part of the dollar’s decline is tied to the unwinding of popular carry trades. Investors had been borrowing yen to buy higher-yielding dollars. But now that trade is unraveling, pushing the yen up 7% against the dollar over the past month. 

The bets against the yen had reached extreme levels last month, levels not seen since 2007. But in recent weeks, those positions have flipped, with traders now going long on the yen for the first time since 2001, according to data from the U.S. Commodity Futures Trading Commission.