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USD Feels Heat as Fed's Dovish Pivot Weighs; EUR, GBP Firm

  • Dollar wallows near 4-month lows; set to end week down 2%
  • Markets expect 150 bps rate cuts from Fed next year
  • Euro and pound buoyant on hawkish rhetoric
  • Yen set for fifth straight week of gains
  • MORNING BID EUROPE-Fed feted, Ueda awaited

SINGAPORE, Dec 15 (Reuters) - The dollar was set for its steepest weekly drop against major currencies since July, weighed by growing prospects of U.S. rate cuts next year, while the euro and pound found support on Friday as central banks in Europe stuck to their hawkish paths.

The spotlight will now switch to Bank of Japan's meeting next week with the central bank likely to end the year as one of the world's most dovish as expectations of the BOJ to exit its ultra loose monetary policy fade.

In an action-packed week for central banks, traders found more clarity on when interest rate cuts were likely after Federal Reserve Chair Jerome Powell said at Wednesday's meeting that the tightening of monetary policy is likely over, with a discussion of cuts coming "into view".

That has resulted in the greenback sliding against rivals, with the dollar index at 102.01, not far from the four-month low of 101.76 it touched on Thursday. The index is down nearly 2% and set for its steepest weekly decline since July.

Chris Weston, head of research at Pepperstone, said the aftermath of the central bank fest is that the market has brought forward the timing of cuts expected in 2024, with many participants now expecting them to start around March.

Markets are now pricing in a 75% chance of a rate cut in March by the Fed, according to CME FedWatch tool.

They are also pricing in 150 basis points in rate reductions by December 2024, double the Fed's projections that implied 75 basis points of cuts next year.

Such market pricing reflects an overly optimistic view of U.S. core inflation being able to return to 2% without requiring substantial economic pain, said Hamish Pepper, fixed income and currency strategist at Harbour Asset Management.

"The risk for markets is that policy rates may need to stay at more elevated levels for longer than anticipated."

The shift in Fed's tone has led Treasury yields lower, with U.S. benchmark 10-year yields sinking to their lowest since July on Thursday at 3.885%. They were last at 3.947% in Asian hours.


On Thursday, the European Central Bank and Bank of England took a different path to the Fed, pushing back against bets on imminent cuts to interest rates and reiterating their focus on the fight against inflation, helping lift the euro and pound.

Still, investor expectations have not been tempered with rate cuts priced in for next year.

The ECB has more scope than most to ease, according to Pepperstone's Weston, given low growth and a rapid decline in inflation.

"However, the pushback from (ECB President) Lagarde and co suggests conjecture on the timing of initial easing – perhaps this is a function that its desirable to keep one's currency strong to limit imported inflation."

The euro was at $1.0985, just shy of $1.1009, a two-week high it touched on Thursday. The currency is up 2% this week, its largest rise since July.

Sterling was last at $1.2766, having surged 1.1% and scaling a four-month peak of $1.2793 on Thursday after BoE's hawkish tilt.

"We suspect markets will ultimately be disappointed with how long they have to wait for BoE rate cuts," said Nick Rees, FX market analyst at Monex Europe.

Rees expects sterling to outperform in the near-term as markets continue to prioritise rate differentials, which should widen in favour of the pound, although the UK’s secular stagnation will likely to lead the pound to underperform.

Meanwhile, the Japanese yen strengthened 0.11% to 141.70 per dollar, having surged 0.7% and touched a four-and-a-half month high of 140.95 on Thursday.

The Asian currency is up 2% this week and on track for its fifth straight week of gains against the dollar. The last time it went on a similar run was during the pandemic in mid-2020.

Reporting by Ankur Banerjee in Singapore. Editing by Sam Holmes and Lincoln Feast.

Source: Reuters

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