Dollar extends losses, euro rallies as traders reassess rate hike bets

[January 13, 2022]  By Tommy Wilkes

LONDON (Reuters) - The dollar fell further on Thursday to two-month lows after U.S. inflation proved weaker than feared in December, prompting investors to cut crowded long positions in the currency.

The euro was a big beneficiary of the move and extended its rise to as high as $1.1479, up 0.3% on the day, while sterling and the yen also added to their gains.

December's monthly U.S. inflation figures, published on Wednesday, were a fraction higher than forecast and the increase in year-on-year consumer price inflation was as expected at 7% - its biggest jump since June 1982.

Nevertheless, traders do not see these inflation readings as urgently shifting an already hawkish Federal Reserve too much. With at least three rate hikes already in the market price, some investors pared bets on further dollar gains.

The dollar index, which measures the greenback against a basket of rival currencies, fell another 0.2% to 94.782.

"The scale of the dollar sell-off must surely be partially indicative of positioning," MUFG analyst Derek Halpenny wrote in a research note.

Halpenny said that so much Fed tightening was now priced in for the next year, expectations for longer-term rate hikes were relatively low, which was keeping the dollar in check.

"Investors appear to be signalling that ending QE (quantitative easing), hiking rates four times and commencing QT (quantitative tightening) all in the space of (9 months) is so aggressive that it will limit the scope for hikes further out. It has in fact reinforced the belief that peak Fed funds will be below 2%," he wrote.

Elsewhere sterling, which has been rallying as traders reckon Britain's economy can survive a surge in COVID-19 cases and that the Bank of England is going to hike rates again as soon as next month, rose 0.3% to $1.3749, its highest since late October.

A picture illustration of U.S. dollar, Swiss Franc, British pound and Euro bank notes, taken in Warsaw January 26, 2011. REUTERS/Kacper Pempel/File Photo

The currency is up 4.5% from December lows and traders have so far shrugged off a political crisis enveloping Prime Minister Boris Johnson, who apologised for attending a party in the Downing Street garden during a coronavirus lockdown last year.

The central bank of New Zealand has already begun hiking rates, and the New Zealand dollar rallied to $0.6884, a gain of 0.5% and its strongest since late November.

Australia's dollar, which tends to perform well when broader market sentiment is improving, added 0.4% to $0.7314.

The Canadian dollar reached a new two-month high, rallying as oil prices gain, with investors looking past the potential economic fallout of the Omicron variant.

"The dollar does not have to increase because the Fed is readying a tightening cycle," said Commonwealth Bank of Australia strategist Joe Capurso.

"It is not a simple equation of Fed hikes equals dollar increases. The dollar is a counter-cyclical currency which decreases as the world economy recovers."

(Additional reporting by Tom Westbrook in Sydney; Editing by Raissa Kasolowsky and Alex Richardson)

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