The US dollar flexed its muscles again in February, despite key data sets on the US economy sending out conflicting signals. It seems that, whenever an element of confusion exists over the direction of the US economy, fund managers swarm back to one of the investment instruments that contains zero risk and yields a real rate of return, albeit marginal.

In January, markets were pricing in several interest rate cuts this year, but capital market traders have since changed their timing of the start of less restrictive monetary policy from May to June. One of the key reasons for the belief that interest rates will remain at current levels for longer is related to the January jump in payrolls data, which came in at 353,000 new jobs, almost double the figure that was expected.

A second reason was the hesitance of the US consumer price index (CPI) to dip below the 3% level in January, with the year-on-year CPI increasing by 3.1%, down slightly from 3.4% in December.  A Reuters poll had forecast the CPI would rise 2.9% on a year-on-year basis (the annual increase in consumer prices has moderated substantially from a Covid-induced peak of 9.1% in June 2022).

With the US dollar index rising by 88 basis points and the yield on the 10-year US Treasury bond rising by 29 basis points, it was rather predictable that most key currencies were going to take a knock against the greenback in February. The only exceptions were the Indian rupee and the Mexican peso, but their gains were marginal.

Turnaround in March

During the first two weeks of March, however, a turnaround occurred in the fortunes of the US dollar, which led to substantial gains for most emerging market currencies. The US inflation rate for February unexpectedly increased to 3.2%, reflecting the difficulty faced by the country’s central bank (the Federal Reserve) in its quest to lower inflation to its benchmark level of 2%.

Economists polled by Bloomberg before the announcement of the latest consumer price inflation (CPI) had expected an unchanged rate from January’s 3.1%. Predictably, the latest rise in the US CPI has already led to a rise in the country’s 10-year bond yield, due to expectations that the Fed may wait longer before cutting interest rates from their current 23-year high.

The decline in the US dollar index was also stopped in its tracks on 13 March. This index, which tracks the greenback’s value against six major currencies, started the year at a level of 101, then gained traction to 105 in mid-February, its highest value in three months.

It may remain fairly stable at its most recent level of 102.8 until such time as there is more clarity on the inevitable lowering of interest rates by the Fed. Until then, emerging market currencies should also hold their own. Since the fourth quarter of last year, most of them have performed exceptionally well, with the Chilean peso, the Turkish lira and the Argentine peso as the only exceptions.

Of late, the South African rand has been amongst the winners in the exchange rate stakes involving the US dollar, which will make it easier to lower inflationary pressures – something that the economy desperately needs in order for interest rates to start receding from their 14-year highs.