EURUSD GBPUSD - Will USD Strength Continue?

Even if we still expect the dollar to turn lower by early 2024, USD upside risks remain material in the near term after the Fed surprised with more hawkish dot plots than market pricing. That may look like a reboot of June’s market conditions, but this time, the room for hawkish repricing in US short-term rates (and USD upside) is smaller.

USD: End of a strong quarter

This week marks the conclusion of the third quarter. The US dollar has exhibited strength throughout the summer, appreciating against all G10 currencies except the Norwegian krone (NOK). As we assess the near-term outlook, it appears unlikely that this trend will shift. The recent dot plot projections released by the Federal Open Market Committee (FOMC) suggest that the Fed is not yet prepared to signal the end of its tightening measures. Instead, a more aggressive "higher for longer" stance has emerged, with the median 2024 rate forecast now standing at 5.1%.

Back in June, when the Federal Reserve presented more hawkish dot plots compared to market expectations, I highlighted a significant upside risk for the dollar. Unless economic data starts indicating a slowdown, markets would eventually need to align themselves with the FOMC's projections. Although the current situation resembles that of June, the gap between the dot plot and market pricing has narrowed.

At present, markets are pricing in an end-2024 Fed rate of 4.67% (effective rate), implying a 65-basis point reduction from current levels. If the 2023 rate hike, as indicated in the Fed dot plots, is not ultimately realized, the theoretical median 2024 rate projection would decrease to 4.85%. This leaves approximately 20 basis points of potential repricing room should US economic data remain robust.

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