U.S. Dollar Index: A Break Below 100 May Come Soon

Key Insights

• Fed’s rate hike did not provide any support to the U.S. dollar. 
• Traders expect that Fed will cut the federal funds rate to 425 – 450 bps by the end of the year. 
• The difference between Fed and ECB policies may put additional pressure on U.S. Dollar Index in the upcoming months. 

U.S. Dollar Index remains stuck nearly yearly lows after Fed’s recent decision to raise the federal funds rate to 500 – 525 bps. The FedWatch Tool indicates that the federal funds rate is expected to remain unchanged at the next Fed meeting in June. The market expects that the Fed will cut the rate to 425 – 450 bps by the end of the year. What does it mean for the U.S. dollar?

Fed Will Likely Cut Rates In 2023

The recent developments in the U.S. banking crisis showed that higher rates have already put material pressure on banks’ balance sheets. While some analysts blame modern technologies that allow quick transfer of money from the troubled banks, the decline in the value of bonds, which happens when the Fed raises rates, is the key driver behind banks’ problems.

While the Fed needs higher interest rates to fight inflation, it cannot put indefinite pressure on the U.S. banking system. At some point, the Fed will be forced to cut rates to provide additional support to banks.

From a big picture point of view, low energy prices should allow Fed to cut rates this year. WTI oil faced strong resistance near the $120 level in June 2022 and settled below the $80 level in recent months. Natural gas declined from $10 to $2. While energy prices are not the only inflation driver, the strong pullback helps the Fed in its fight against inflation and provides an opportunity to start cutting rates in 2023.

U.S. Dollar Index May Settle Below 100

U.S. Dollar Index has settled near the 101 level. The recent rate hike from the Fed did not provide support to the American currency as traders have already started to prepare for rate cuts in the second half of the year.

While the Fed will likely begin to cut rates, the ECB is forced to keep raising rates as inflation stays at high levels. ECB President Lagarde has recently stated that ECB was not pausing. The difference between the Fed policy and the ECB policy may put additional pressure on the U.S. dollar in the second half of the year. In this scenario, traders who are willing to bet on Fed’s rate hikes may push the U.S. Dollar Index below the psychologically important 100 level in the upcoming months.

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