London (Reuters) -With a U.S. interest rate hike expected this week and growing uncertainty about the Fed’s plan to tighten policy, the dollar stayed away from recent 20-year highs on Tuesday, while Russia’s latest gas cut kept the euro under pressure.
Later in the day, the U.S. Federal Reserve starts a two-day meeting where they are likely to raise interest rates by 75 basis points. But many traders are wondering if the Fed will change its focus away from inflation if growth slows. This could mean that the Fed will raise rates more slowly in the future.
Futures contracts tied to the Fed’s policy rate show that interest rates will peak in January 2023, which is a month earlier than the reading they gave last week for February. At the same time, long-term Treasury yields have dropped about 80 basis points from their highs in mid-June.
This has helped bring the dollar down about 2.8% from its 20-year high of 109.29 against a group of currencies, which was reached less than two weeks ago. By 8:30 GMT, the dollar had stayed about the same for the day at around 106.5, but it had gone up slightly against the euro to $1.0219.
But even though Fed rate expectations are going down, most analysts are still bullish on the dollar because they see signs of a slowdown in the world economy. On Monday, a profit warning from the U.S. store Walmart made these fears even stronger (NYSE:WMT).
This happened after several U.S. and European data prints were weaker than expected.
Francesco Pesole, an FX strategist at ING Bank, said that traders’ cutting back on their “long” dollar positions were to blame for the dollar’s loss of momentum.
“The reassessment of when terminal rates would be reached and the talk of rate cuts may have been the cause of position squaring,” Pesole said.
“But there is less room for dovish repricing at the Fed than at the ECB… Fed pricing is more or less in line with the dot-plot and the inflation/growth outlook,” he said, referring to the chart that shows each Fed official’s interest rate prediction.
Uncertainty about Europe’s energy security kept the euro from moving much. On Tuesday, Russia said that gas flows to Germany through the Nord Stream 1 pipeline would drop to 33 million cubic metres per day (bpd) starting Wednesday. That equates to half of current flow, which is already only 40% of normal capacity.
So far, the single currency hasn’t reacted much to the news, even though it could lead to fuel rationing in Europe and a recession.
Pesole said the euro had been braced for bad news on the gas front, noting “the reaction function to incoming news is not as sharp and won’t trigger the same kind of volatility as a month ago”.
The euro could weaken, however, if markets actively start pricing out upcoming rate hikes from the European Central Bank—they have already scaled back expectations for September, now pricing a 39 bps hike compared to 50 bps last week.
The Australian and New Zealand dollars are doing well because of the prices of commodities. The Aussie reached a one-month high of $0.6984 as iron ore prices hit highs not seen in two weeks and traders waited for inflation data that could show consumer prices are rising at the fastest rate in more than 30 years, at 6.2 percent year-on-year.
Analysts at ANZ Bank said, “Depending on the data, there may be a slight uptick for the Aussie.” It’s almost certain that the Reserve Bank of Australia will raise rates by 50 basis points next week. A bigger increase is the main risk. “
Elsewhere, cryptocurrencies lost some of the gains they made last week. At $21,100, bitcoin was at its lowest point since July 18. At $1,421, Ether also hit its lowest point since July 18.