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The dollar posted its strongest weekly performance since 2022 after stronger-than-expected US inflation data caused ripples across global markets.
The U.S. currency strengthened 1.7% against a basket of six currencies since Monday, its best weekly performance since September 2022, as traders reversed bets on early interest rate cuts by the Federal Reserve.
The euro and pound fell to their weakest levels against the dollar since November on Friday at $1.0642 and $1.245, respectively, while the yen fell to a 34-year low, before recovering to 153.28 yen.
The pound’s decline also contributed to a 0.9% rise in British shares on Friday, as the FTSE 100, whose constituent companies derive most of their revenue in dollars, ended the day’s trading just before a record closing.
“The United States is a special case, with very loose fiscal policy and now tight monetary policy, which is a recipe for a stronger dollar,” said Quentin Fitzsimmons, senior portfolio manager at T Rowe Price. “The buzzword circulating in the markets at the moment is divergence”.
This week’s rise in U.S. consumer price inflation – which reached a higher-than-expected 3.5% for March – has prompted traders to increase bets that the Fed could bring even more a rate cut this year.
That compares with expectations of as many as six quarter-point cuts in early January.
On Thursday, the European Central Bank signaled that it was still on track to cut interest rates in June. Pressure on the euro has increased due to growing expectations that Eurozone interest rates will fall more than those in the United States.
By Friday afternoon, the single currency had fallen 1.8% for the week, the biggest weekly drop since September 2022.
“It appears that a happily divergent ECB has weakened the euro against the dollar,” said Chris Turner, head of global markets at ING.
The shift in sentiment helped push the spread — or gap — between benchmark 10-year U.S. and German government borrowing costs to 2.17 percentage points, the highest level since 2019.
Speculation has also mounted that Sweden’s Riksbank could cut interest rates as early as May, after the country reported lower-than-expected inflation on Friday.
According to analysts, fears of an imminent attack by Iran against Israel, in response to an airstrike on the Islamic Republic’s consulate in Syria, may also have contributed to the dollar’s strong recent run.
“Growing tensions between Iran and Israel may result in even higher oil prices, all to the benefit of the dollar in the short term,” said Francesco Pesole, currency analyst at ING.
The dollar is considered a safe haven for investors during times of heightened geopolitical uncertainty.
The dollar’s sustained strength could cause problems for countries looking to cut rates without weakening their currencies and accelerate price increases.
The outlook has been complicated by a surge in oil prices, with Brent crude climbing above $92 a barrel for the first time since October on Friday, amid growing fears of a widening conflict in the Middle East.
“Other central banks clearly don’t want their currencies to weaken materially. . . that means you will actually end up importing more inflation,” said James Novotny, portfolio manager at Jupiter Asset Management.
Markets are betting that the ECB will make cuts of at least three quarters of a point by the end of the year, compared with two cuts for the Bank of England and just one or two for the Fed.
The Japanese currency suffered the most as rising U.S. rate expectations pushed the yen to its weakest level since 1990, putting the Finance Ministry on red alert for possible intervention.
Masato Kanda, Japan’s vice minister for finance and international affairs, told reporters Thursday that authorities would not rule out any measures to address excessive exchange rate movements.
Mark Dowding, chief investment officer at RBC BlueBay Asset Management, said the impact of any intervention would be costly and temporary.
“The yen has been undermined by the politics of [Bank of Japan]which is too dovish,” he said. “It appears the yen remains vulnerable only because the political gap remains painfully wide.”