Financial markets have begun 2023 on a cautious note, see-sawing on mixed data. Although it has dropped back today, the US dollar has started the new year on the front foot, rising against most other major currencies on the week as a whole. That said, the key driver of the dollar’s rally for much of 2022 – the relentless rise of expected US interest rates – has continued to reverse as market participants increasingly disregard the Fed hawkish guidance. The minutes from the FOMC’s December meeting reiterated policymakers’ determination to keep financial conditions tight but, with the economy showing further signs of weakness, rate expectations have dropped back further.
While US labour market data remain solid, forward-looking indicators – notably today’s ISM services survey, which dropped below the 50-mark suggesting contraction – painted a less optimistic picture. Our central expectation remains that the dollar will rebound as the global economy slides into recession and safe haven demand replaces interest rate differentials as the key driver of the dollar.
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