Is the dollar a victim of a new interest rate shock?

While the US central bank still has inflation in its sights, the financial world is already looking at the next problem. It seems only a matter of time before recession concerns are reflected in a reversal of interest rates and a slide of the dollar.

For a while last month it seemed that the US central bank (Fed) would be distracted from its mission to bring inflation under control. On March 22, the key interest rate rose by 0,25 percentage point, while economists initially expected 0,5 percentage point. Due to the unrest in the banking sector after the bankruptcy of Silicon Valley Bank, the Fed did not dare to make a major interest rate move. But in a speech earlier this week, Fed director Loretta Mester said that interest rates are going to rise a little further. In her view, this is necessary to push inflation down towards the 2% level and, at the same time, to ensure that long-term inflation expectations also fall somewhat. 

Shift focus
Nevertheless, the financial market is not convinced that this interest rate increase will come with the interest rate decision on May 3. Trading platform CME continuously gauges the interest rate expectations of a group of economists. Yesterday, only 40% of those surveyed expected interest rates to go one step higher. But it is mainly the expectations for the end of this year that attract attention. According to almost half of the CME panel, the policy rate will then be at least one percent lower than now. A large group of economists anticipate that the Fed's focus will shift from pushing inflation down to boosting an economy that threatens to cool down too quickly.

Hairline cracks in the US economy
This group fears that the problems at Silicon Valley Group are part of a larger underlying problem in the banking sector. Many other local banks are still struggling with major losses on their investment portfolios. In addition, there are increasing signs that the US economy is not running as strong as it seemed at the beginning of 2023. For example, preliminary figures from data processor ADP showed that 145.000 jobs were added in March. That was a lot less than the 240.000 from a month earlier and the 210.000 that analysts were counting on. On the same day, it was announced that the total import value in February fell by 1,5% to $321,7 billion. The United States imported fewer smartphones, consumer goods and clothing, among other things.

Finger on the snap
This is an indication that Americans are keeping their fingers crossed due to rising interest rates. If the Fed makes the policy change that more and more economists are anticipating, it could have major consequences for the dollar. After June 2021, the prospect of rising US interest rates fueled another fire under the currency. The dollar rose by more than 20% against the euro. Falling interest rates may cause the currency to lose ground. Since the beginning of October, the dollar has already fallen by about 10%. If interest rates actually start to fall in the United States, it may just be the start of a bigger price ride.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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