Year-End Dollar Slump: Fed and Geopolitics Stir the Pot

Last updated: November 19, 2023

The greenback’s traditional year-end dip might not be a sure bet this time around, thanks to a cocktail of economic and geopolitical uncertainties.

Year-End Dollar Slump
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The US dollar has typically felt the squeeze from holiday trade flows, a seasonal risk appetite, and year-end book closing. But this year, the Federal Reserve’s policy effects and Middle East conflicts could throw a wrench in the works.

The Bloomberg Dollar Spot Index has seen a December slump for six consecutive years, averaging a 1.4% drop. However, this year, the dollar bears might find themselves on shaky ground.

“Real rate spreads are, relative to the last five years, favoring the dollar a lot more this time around,” says Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore. He adds, “Clearly the elephant in the room is we’ve got unprecedented policy tightening that’s come through,” and then “you’ve got geopolitics thrown into the mix.”

The US economy’s robust data and the Fed’s potential rate hike could further bolster the dollar. The business market is factoring in a 20% chance of a year-end hike, and the 10-year Treasury yield is inching towards the 5% mark, its highest since 2007.

The dollar has defied expectations, riding the wave of economic trends and yield surges to gain over 2% in 2023, while the Asian dollar index has dipped nearly 5%. “They always say the past tends to repeat itself, but I think this time it’s a bit more difficult to say,” notes Wei Liang Chang, macro strategist at DBS Bank.

Asia’s currencies could see a lift if China’s recovery gains momentum, especially with Beijing’s recent $137 billion economic aid announcement. However, the path of US yields, a key comparison point for regional assets’ potential returns, will also play a crucial role.

Mitul Kotecha, head of FX and EM Macro Strategy, Asia at Barclays, observes a broad trend of weakness across Asia but remains cautiously optimistic. “Going into the end of the year, things may look a little bit better in some senses because we’ve had some pullback in US yields, we’ve had the dollar looking like it’s facing a little bit more resistance and data in China has shown some improvement.”

However, Varathan warns against betting against the dollar too heavily, given the multitude of external factors at play. “We should be prepared for a very unseasonable year,” he concludes.

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