Dollar touches five-month low on rate cut hopes in thin market

By Samuel Indyk and Ankur Banerjee

LONDON (Reuters) -The dollar slipped to a five-month low on Wednesday and the euro touched a four-month peak on expectations that the Federal Reserve could soon cut interest rates, but thin year-end trading flows limited moves.

With many traders out for holidays, volumes are likely to be muted until the New Year.

The dollar index, which measures the U.S. currency against six rivals, fell to 101.41, its lowest level since July 28. The index is on course for a 1.9% drop in 2023 after two straight years of strong gains, driven by the anticipation of Fed rate rises and then the Fed’s actual rate increases to battle inflation.

“Overall, from a global perspective, I expect markets to remain quiet,” said Jens Magnusson, chief economist at SEB.

“We still have strong equity markets and that is likely to hold through to New Year. If nothing happens geopolitically then currency markets will stay fairly calm over the next few days.”

The recent weakness in the dollar – the index is set to clock a second straight month of losses – has been spurred by the markets anticipating Fed rate cuts next year, denting the dollar’s appeal.

Markets are now pricing in a 85% chance of a rate cut starting in March 2024, according to CME FedWatch tool, with over 150 basis points of cuts priced in for next year.

US data showing cooling inflation has emboldened bets on rates easing next year.

“Disinflation is proving entrenched (and) expectations are for central banks to pivot next year while growth is still trudging along,” said Christopher Wong, a currency strategist at OCBC in Singapore.

“This paints a goldilocks market that is favourable for risk proxies,” such as equities and higher risk currencies.

Meanwhile, the euro was up 0.1% at $1.1053, having touched a four-month high of $1.1055. The single currency is up nearly 3% in the year and is on course for a third straight month of gains, matching the run it had last year.

“Overall, as long as the soft landing narrative is alive and well and there’s healthy risk appetite, then I think people will be looking more towards the euro rather than the dollar,” said SEB’s Magnusson.

The Japanese yen weakened 0.1% to 142.52 per dollar and is headed for an 8% drop in the year although the Asian currency has witnessed a bout of strength in recent weeks reflecting expectations the Bank of Japan will soon exit its ultra-loose policy.

A summary of opinions at the central bank’s Dec. 18-19 meeting showed that BOJ policymakers saw the need to maintain its ultra-easy monetary policy for now, with some calling for a deeper debate on a future exit from massive stimulus.

The summary of opinions was somewhat dovish and showed no sense of urgency to end the ultra-loose policies, according to Saxo strategists.

The likely timing of the end of the policies will be later than what the market is anticipating, the Saxo strategists said in a note.

The Australian dollar and the New Zealand dollar both touched a new five-month peak earlier in the session. The Aussie last bought $0.6836, while the kiwi was at $0.6324.

(Reporting by Samuel Indyk in London and Ankur Banerjee in Singapore; Editing by Michael Perry, Muralikumar Anantharaman and Jane Merriman)