The future of the dollar amid recession fears and earnings season

The end of rate cycle is near

By Raed Alkhedr | @raedalkhedr | 14 April 2023

US Dollar Index is awaiting the Federal Reserve-13
  • Earnings season post banking sector turmoil and amid rate hikes

  • The dollar and gold prices fate for May

  • Clarity on recession probabilities

Global markets have witnessed strong volatility during the last period due to growing concerns about the world economy entering a recession. This has occurred simultaneously with a rising demand for safe investments, particularly gold, which reached a new peak in 2023 with a value of approximately $2045 per ounce.

Conversely, the US dollar is facing significant strain, with the dollar index falling back to levels around 101.00. Numerous predictions suggest that the value of the dollar may further decrease in the foreseeable future due to several reasons, which are highlighted below;

- Recession fears in the US

Lately, concerns have been rising about a potential recession in the world's largest economy, particularly following the Silicon Valley crisis. Some experts argue that this crisis is distinct from the global financial crisis and is not connected to the surge in commodity prices or the high levels of risk-taking among investors.

The present crisis stems from Silicon Valley's investment in long-term bonds in an effort to increase their profits, taking advantage of the US Federal Reserve's strategy of reducing interest rates and injecting substantial liquidity into the market during the Covid-19 pandemic in 2020.

With the bank not taking adequate safeguard measures, the bank was exposed to what is known as interest rate risk. The US Federal Reserve subsequently initiated a rapid and forceful increase in interest rates, causing bond yields to fall significantly as a result.

In addition, most investors, especially tech startups, have tended to withdraw their money to provide liquidity as monetary policy continues to tighten.

It is important to note that the recent increase in interest rates by the US Federal Reserve could have negative consequences that should not be ignored. This was the most vigorous monetary tightening approach adopted by the Fed to date. Therefore, even if the adverse effects of these policies are not immediately apparent, they may still exert pressure on the economy in the future.

- Disappointing economic data

Since the beginning of the second quarter of 2023, disappointing data continued to dominate the US economy. Some believe that the negative repercussions resulting from the US interest rate hike have begun to appear in most sectors that have suffered from a contraction or a significant slowdown in growth.

But at this time, markets are preparing for the corporate earnings season in the first quarter of the year, where they will be the decisive in assessing the state of the US economy, and the extent to which companies are affected by monetary tightening policies. Any signs or signs that U.S. companies or banks are suffering would be an early indication that the world's largest economy is indeed likely to slide into recession and mount fears of contagion of U.S. bank bankruptcies.

- Markets are ready to reduce the pace of monetary tightening

After a year of unprecedented aggressive monetary tightening by the US Federal Reserve, markets are preparing for the Bank to start abandoning those policies.

This situation follows the release of economic data demonstrating the success of the US Federal Reserve in managing the pace of inflation, which was a critical factor in the decision to implement the substantial interest rate hike. Following a surge to its highest level since the 1980s, inflation has started to taper off gradually, reaching 5% in March.

Although the current inflation rate of 5% remains below the target set by the Fed, the persistent deceleration in inflation growth has led the markets to anticipate a significant reduction in the pace of interest rate hikes. This is particularly true given the ongoing disappointing economic data and the looming apprehension of a Silicon Valley crisis.

Most expectations now support a rate hike at the May meeting by another quarter of a basis point. However, starting with the June meeting, markets expect CME Group markets to fix interest rates for the first time since February 2022.