Dollar Wins Over Doubters as Tightening Countdown Begins

© Reuters.

By Yasin Ebrahim

Investing.com – The dollar is winning over some of its detractors who have been pushed off the bearish bandwagon after the Federal Reserve's hawkish tilt started the countdown on policy tightening much earlier than expected.  

The U.S. dollar index, which measures the greenback against a trade-weighted basket of six major currencies, fell by 0.29% to 92.37.

The dollar has racked up gains since hitting a bottom in May, but for many, this run higher would turn out to be nothing more than relief rally, and losses would soon follow in the second half of the year as the downtrend resumes.

The crux of the bearish bet centered around the Federal Reserve's ultra loose monetary policy staying intact, while the European and global economy continued to recover. Unfortunately, caught wind of the faster pace of inflation, and made a hawkish pivot that has rocked the short dollar bet. 

ING on Thursday slashed its outlook on the EUR/USD to $1.23 from $1.28, conceding that its bet on weaker dollar into the back of the year was unlikely to take shape.

"On the assumption that the Fed starts formally tightening in 3Q22, it would be no surprise to see a bearish flattening of the US yield curve – preparing for the Fed to apply the monetary brakes – from 2Q22 onwards," ING said in a note. "That is when we would expect the dollar to embark on a broad rally."

For the months, the Federal Reserve shrugged off the turn up in the pace of inflation as transitory, and said it would let it run above target for some time under its new average inflation targeting regime. But the central bank's resolve to persist with this regime change was tested when inflation hit the highest levels in years.

"What has changed is that the Fed looks less committed to Average Inflation Targeting and more towards a conventional lift-off in rates which could come as early as autumn 2022," ING said in a note. "This assumes the Fed starts tapering shortly after the August Jackson Hole gathering– a tapering process that could last until spring/summer '22."

The Fed's worries over inflation were a hot topic in their June meeting.

"Although they generally saw the risks to the outlook for economic activity as broadly balanced, a substantial majority of participants judged that the risks to their inflation projections were tilted to the upside because of concerns that supply disruptions and labor shortages might linger for longer and might have larger or more persistent effects on prices and wages than they currently assumed," the Fed's minutes showed.