Dollar Plunges as Traders Bet on Aggressive Fed Rate Cut

The US dollar has tumbled to near its weakest level since January as traders increasingly anticipate a more aggressive interest rate cut by the Federal Reserve this week. The greenback's decline has boosted major currencies like the Japanese yen, which has risen to its highest level since July 2023.

Traders Favor Bigger Fed Rate Cut, Signaling Weaker Dollar Ahead

Traders Bet on 50-Basis-Point Cut

After weeks of debate over whether the Fed will initiate its policy easing with a 25 or 50 basis point cut, traders are now favoring the latter option. Futures linked to the Fed's decision this week are pricing in around a 58% chance of a half-point cut, compared to a coin toss late last Friday. This shift in market sentiment suggests that traders are increasingly convinced the central bank will take a more aggressive approach to stimulate the economy.

Dollar Weakness Seen as "Major Headwind"

The prospect of a more dovish Fed is seen as a significant headwind for the US dollar. "We see a new and imminent Fed easing cycle as a major headwind for the dollar," said Rodrigo Catril, strategist at National Australia Bank Ltd. "The dollar will embark on a cyclical decline as the Fed eases and takes the fund rate toward neutral, if not below, next year."

Greenback Weakens Against Peers

The greenback has already weakened against most major currencies over the past month, with once beaten-up peers like the yen and Swiss franc among the biggest winners against the dollar. Japan's currency extended gains again on Monday, advancing past the closely watched 140 per dollar level as investors bet on narrowing interest rate differentials between the two nations.

Technical Indicator Signals Support for Dollar

Despite the bearish sentiment surrounding the dollar, a technical indicator is signaling support for the currency. "While the Fed's easing cycle is at risk of being front-loaded, we think the market is overpricing this risk and the Fed will cut rates by 25 basis points this week, which would give the dollar a bounce," said David Forrester, strategist at Credit Agricole CIB in Singapore.

Market Overwhelmingly Expects Weaker Dollar

However, the market is overwhelmingly in the camp of a weaker US currency. Bloomberg surveys of analysts show that the euro, yen, Canadian and Australian dollars are all forecast to strengthen against the greenback by this time next year.

Dovish Fed Could Alter Global Inflation Projections

An unexpectedly dovish Fed could have far-reaching implications beyond just the US dollar. "An unexpectedly dovish Fed could weaken the dollar," Bob Savage, head of markets strategy and insights at BNY, wrote in a note. This could "alter inflation projections for nations, such as Britain that import dollar-priced commodities and prompt Norges Bank to support the oil-linked crown," he added.