Weekly review of the foreign exchange market: the Federal Reserve's interest rate cut expectations rose to dominate the market, the dollar index weakened, and the Canadian dollar continued to strengthen

On Friday (December 15), under the pressure of increasing the prospect of interest rate cuts next year, the US dollar suffered a heavy blow this week, returning to the August 10 level. The dovish turn of the Federal Reserve and risk appetite continue to weigh heavily on the US dollar. The recent good recovery in oil prices has supported the Canadian dollar due to the continued selling of the US dollar, and the US dollar/Canadian dollar further fell below 1.3400, the lowest level since mid-August. The Canadian dollar/Chinese yuan continued to climb to the early November level.

The dollar index, which measures the greenback against six major currencies, rose 0.53 percent on Friday to 102.51.

(Dollar index trend chart,)

In a busy week for the central bank, traders learned at Wednesday's meeting that monetary policy tightening may be over, and then Federal Reserve Chairperson Jerome Powell said he would begin discussing a rate cut, providing a clearer picture of when rates will be cut.

The latest interest rate forecasts released by Federal Reserve officials on Wednesday showed an expected rate cut in 2024, causing the dollar to fall sharply.

The Federal Reserve signalled a turnaround, with officials issuing forecasts for a series of interest rate cuts next year. Fed Chairperson Jerome Powell said he was ready to resume raising interest rates if price pressures returned, but he also said the topic of easing was brought up at this week's meeting. Mr. Powell's remarks, also interpreted as taking a more dovish tone, said the tightening of monetary policy might be over and that talk of rate cuts would "come into view". "To be fair, what Williams said is also what Powell said at this week's meeting," commented analyst Sebastian Boyd. "It remains to be seen whether this will be a good antidote to the sharp rise in bonds, but given how bonds have moved over the past few days, such a repression could have the effect of stabilizing the market."

Bipan Rai, head of North American FX strategy at CIBC, said "This is somewhat similar to the tone we heard from Powell earlier this week, but it kind of reinforces the fact that the Fed is still very much a data-dependent bank and doesn't really endorse the market's pricing of the economy." Rai also noted that much of the dollar's move this week was due to rebalancing dollar positions heavily tilted towards the dollar and focusing on specific currency pairs, such as against the yen. "This is a story about the market being over-leveraged and skewed positions that needs rebalancing more than any dovish interpretation of Powell's remarks earlier this week," he said.

The dollar rallied on Friday after "hawkish" comments from several Fed officials overturned market expectations of a rate cut, but the index is still on track for its worst weekly performance in a month.

John Williams, the chairperson of the New York Fed's "three-handed" Fed, today rejected suggestions that the central bank had already begun talking about cutting interest rates. "We're not really talking about cutting rates," he said. "It's too early to think about cutting rates in March. The question is whether we have adjusted monetary policy to a restrictive enough stance to ensure that inflation falls back to 2 percent."

Commenting on Mr. Williams' remarks, Nick Timiraos, the Fed's megaphone, said: "The Fed's focus on whether it's doing enough to raise interest rates is clearly a rebuttal to the mood at the Fed press conference on Thursday. Cutting rates'is not a topic of discussion about what we're going to do '."

Earlier this week, traders digested positive expectations for a rate cut, with the first likely in March and a 145 basis point cut in December.

PepperstoneResearch director Chris Weston said the Fed's statement has brought forward the market's expectations for a rate cut in 2024, with many participants now expecting a rate cut to begin around March next year.

According to the CME FedWatch tool, the market currently expects a 75% chance of a rate cut by the Federal Reserve in March.

Hamish Pepper, fixed income and currency strategist at Harbour Asset Management, said this market pricing reflected over-optimism that US core inflation could return to 2 per cent without the need for large-scale economic pain. "The market risk is that policy rates may need to be held at higher levels for longer than expected."

After Williams' speech, the yield on the 10-year benchmark US Treasury bond fell 1.35 basis points to 3.9073%. It was trading in the range of 3.9709% -3.8924% during the day, and it has fallen 31.84 basis points this week. The yield on the two-year Treasury bond rose 5.67 basis points to 4.4491%. It was trading in the range of 4.3546% -4.4827% during the day, and fell 27.18 basis points this week. JPMorgan Chase lowered its US Treasury yield forecast. The dovish signal from the Federal Reserve prompted JPMorgan Chase's economic team to cut the Fed's interest rate forecast by the end of 2024 by 25 basis points to 4.1%. In its report on Thursday, JPMorgan expects the yield on the 10-year Treasury to be 3.65% by 2024, down 10 basis points from its previous forecast. JPMorgan expects the yield on the two-year Treasury to fall to 3.25% from its previous forecast of 3.5%.

The U.S. economic calendar data on Friday was skewed to the downside. The U.S. services PMI hit its highest level since July in December, and manufacturing remained a drag on the economy. Chris Williamson, chief business economist at S & P Global Market Intelligence, said the data showed that the U.S. economy picked up slightly in December, ending the year at its fastest pace since July... However, despite the U.S. economy improving in December, the PMI survey showed that the country's GDP growth in the fourth quarter was rather weak. Loose financial conditions have helped to boost demand, business activity and employment in the services sector, and have also helped to raise expectations for future output. However, the rising cost of living and the cautious attitude of households and businesses towards spending mean that the overall growth rate of the services sector remains well below the levels seen during the recovery in travel and leisure activities in the spring and summer. At the same time, manufacturing continues to weigh on the economy, with the decline in orders accelerating, prompting factories to cut production, lay off workers and scale back input purchases. Therefore, despite the economic recovery in December, the survey showed that GDP growth in the fourth quarter remained sluggish.

U.S. industrial output rebounded in November, reflecting a pick-up in production activity by automakers and parts suppliers following the end of the United Auto Workers (UAW) strike. Data showed manufacturing output rose 0.3 percent last month, less than expected, driven by a 7.18 percent surge in auto production. Excluding cars, however, manufacturing output fell 0.2 percent. Total industrial production, including mining and utilities, rose 0.2 percent.

U.S. Congressional Budget Office: Revised its forecast for real U.S. gross domestic product (GDP) growth in 2023 from 0.9% in July to 2.5%, reflecting data as of December 5. The average unemployment rate is projected to be 3.9% in the fourth quarter of 2023 and 4.4% in the fourth quarter of 2024 and 2025. Forecast a 3.4% increase in the core personal consumption expenditures (PCE) price index in 2023, down from 4.1% expected in July; Forecast a 2.4% increase in the core PCE price index in 2024.

Bank of America strategists led by Sebastian Raedler say falling inflation, dovish central bank repricing and falling real interest rates have gained the upper hand in the face of slowing economic growth. The elasticity of hard data from the post-epidemic order backlog has supported stock market and earnings per share forecasts, keeping hard data high relative to soft data, but this is at odds with sluggish demand in soft data such as PMI new orders. The support from the order backlog is expected to weaken, further affecting the softer data.

TD Securities strategists now expect the Fed to start easing monetary policy in May rather than June as it preemptively focuses on achieving a soft landing. TD Securities analysts Oscar Munoz and Gennadiy Goldberg said the less restrictive FOMC policy and signs of an "increasingly improving inflation outlook" had prompted a change in Fed policy expectations. The bank still expects a cumulative 250 basis point rate cut, including 200 basis points next year, as growth concerns could lead the Fed to concentrate policy easing in the early stages of 2024.

Atlanta Fed President Raphael Bostic said Friday that a rate cut is not imminent, but has directed staff to begin developing possible principles and thresholds to guide the process. He does not expect the Fed to cut the U.S. base rate until mid-2024, the first Fed official to reveal a timeline for a possible rate cut since the Fed released a hawkish dot plot that beat expectations in September. Two 25-basis point rate cuts are expected in 2024, with the first taking place "sometime" in the third quarter, assuming progress on inflation expectations continues. "The Fed needs to be careful, patient and determined to achieve its objective of bringing inflation down to 2 per cent," he said in an interview with the media. The remarks echoed the tone of remarks by colleagues at the Federal Reserve. Publicly available information shows that Bostic is one of the members of the FOMC voting committee in 2024.

Brainard, economic adviser to US President Joe Biden, said there is every reason to expect more progress in inflation, more feasible room for a soft landing in the US economy, and financial marekt reflects a more positive view of the economic development path.

The Federal Reserve may need to shift its focus to a measure of employment, and does not rule out a rate cut at its March meeting, according to Chicago Fed chairperson Ben Goolsbee. He believes there should be more focus on the risk of rising unemployment as inflation moves back towards its 2 per cent target. "If the data supports it, I would support a rate hike, but if inflation continues on its current path, a rate cut may be appropriate," he said. "Next year rates are expected to be lower than they are now, but not significantly lower."

USD/CAD fell for the third consecutive session, falling to the mid-August level and trading at 1.33648, down 0.30%.

(Dollar/CAD exchange rate chart,)

On Friday, Canada released a series of economic data, of which the annual rate of wholesale inventory in October was 2.1%, the previous value was 0.9%; Canada's overseas investors bought Canadian securities in October - 15.75 billion Canadian dollars, and Canada's new housing start data in November was 212,600 households.

Ahead of the Bank of Canada governor's speech, Canadian economists expect Bank of Canada Governor Michael McClum to hit back again at expectations of a rate cut in early 2024. BMO capital markets expects Mr. McClum to at least reiterate that the central bank is ready to raise rates again if inflation fails to cool as forecast. Derek Holt, economist at Scotiabank, said the Fed's decision this week could complicate Mr. McClum's messaging. However, the situation in Canada is different, with wages rising amid a productivity slump and immigration-driven population growth pushing housing inflation to record highs.

The Bank of Canada increasingly believes that interest rates are restrictive enough. Bank of Canada Governor Macklum said that inflation is still too high and if we do not do enough, we may have to raise interest rates further; Will not give up the option of further interest rate hikes; Data since the last decision increasingly points to monetary policy being in play; We have not discussed a rate cut. Macklum said, "The Fed will do what is necessary while we focus on what is necessary." At the same time, he expects economic growth and employment to improve after 2024 and inflation to be close to the 2% target. Macklum said, "The 2% inflation target is in sight; we are not there yet, but conditions are increasingly conducive to achieving it. Once we are convinced that we are clearly on the path to return to price stability, we will consider whether and when we can cut rates. "

The Canadian dollar has appreciated recently. Nonetheless, economists at the National Bank of Canada do not expect the Canadian dollar to strengthen further. They said, "There is not much room for the Canadian dollar to appreciate until the second half of 2024. Looking ahead, given our forecast for a global slowdown and the possibility of larger interest rate cuts in Canada relative to the United States due to weak domestic demand, we do not see much support for the Canadian dollar. Given the Canadian recession in the first half of 2024, we now expect USD/CAD to rise to 1.45 in the coming quarters and do not see room for appreciation until the second half of 2024."