US dollar firmly under pressure as easing inflation unwinds long positions

The US dollar remains under pressure on Friday, hovering near a 15-month low and heading for its biggest weekly decline since November. The recent softening US inflation data has fueled investors’ belief that the Federal Reserve is nearing the end of its rate hike cycle, further adding to the downward pressure on the greenback.

On Thursday, data revealed that US producer prices barely rose in June, resulting in the smallest annual increase in producer inflation in nearly three years. This follows modest consumer price growth reported earlier in the week. The combination of these factors has led investors to bet on a soft landing for the US economy, which has contributed to the weakening of the dollar.

Carol Kong, a currency strategist at Commonwealth Bank of Australia in Sydney, commented on the market sentiment, stating, “Markets are generally pretty pleasant with the lower inflation data because lower inflation together with the still resilient labor market supports the narrative of a soft landing in the US economy.” However, Kong added that their view maintains that the US is likely to enter a recession later this year due to the impact of past and potential future interest rate hikes.

The dollar index (DXY), which measures the US currency against six major peers, experienced a slight 0.03% increase to 99.803 on Friday, after touching a 15-month low of 99.574 earlier in the day. Nevertheless, the index is down 2.4% for the week, marking its most significant weekly decline in eight months.

According to the CME FedWatch tool, markets are still pricing in a 95% chance of a 25 basis point rate hike from the Federal Reserve later this month. However, expectations for additional rate hikes throughout the rest of the year are diminishing.

Investors have been anticipating a turnaround in the dollar for several months, resulting in short positions more than doubling since the start of July. Although these positions are still far from the levels observed in 2021, they indicate a growing bearish sentiment towards the greenback.

Federal Reserve officials, on the other hand, remain cautious. Federal Reserve Governor Christopher Waller emphasized that he is not ready to declare an “all clear” on US inflation and favors further rate increases later this year.

Amid the dollar’s weakness, the euro reached a fresh 16-month peak of $1.1243 during Asian trading hours before leveling off at $1.1225. Francesco Pesole, an FX strategist at ING, noted that the euro-dollar pair has now entered overvaluation territory based on their short-term fair value model.