USD Reverses 2023 Loss, Adding Potential Rate Hikes

The dollar strengthened against all key competitors on Friday, wiping out its year-to-date losses on rising expectations for further Federal Reserve rate hikes.

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In preparation for a third weekly gain, the Bloomberg Dollar Spot Index increased as much as 0.6% on Friday. According to dealers based in Europe who are familiar with the trades but asked not to be identified because they aren't permitted to talk publicly, real money has bought the dollar this week in magnitude, primarily against the euro and the yen.

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Investors' perceptions of the outlook for rates have changed as a result of improved US economic data and hawkish remarks from Federal Reserve officials, which has increased the dollar's allure. By July, traders now anticipate an additional 73 basis points of increases, up from 62 at the end of last week.

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According to David Forrester, senior FX strategist at Credit Agricole CIB in Singapore, "strong US cyclical and inflation indicators have markets finally coming around to the concept the Fed is correct and that rates will have to go much higher."

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Two of the Fed's most hawkish officials hinted on Thursday that they would support resuming larger rate increases in the future to combat inflation. Statistics revealed that producer prices recovered in January by a greater amount than anticipated, highlighting ongoing inflationary pressures that are raising expectations for the peak Fed rates.

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Derek Halpenny, head of research for global markets at MUFG in EMEA, stated in a note to clients that "the momentum in FX points to news like these as having a definite impact on driving the dollar further stronger."

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Viraj Patel, a strategist at Vanda Research in London, believes that this should serve as a wake-up call to the generally held pessimistic stance on the dollar. According to him, investors overvalued the dovish Fed turn and the US economy's performance abroad, which caused the dollar to fall more than 2.5% early this year.

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The dollar's gain won't last very long, according to HSBC. The company's strategists predict a new "flip" in the second quarter as uncertainties, such as those surrounding the Fed's hike schedule, fade. While this is going on, RBC BlueBay Asset Management has advocated adding to long bets in the Japanese yen, which on Friday plummeted to its worst level versus the dollar since December.

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The Fed might not be significantly more dovish than other central banks this year, according to Vanda's Patel. "We're approaching dollar levels that fairly represent the state of the American macro outlook."