The dollar jumped to a five-year high against the Japanese yen on Tuesday as traders raised their bets on Federal Reserve rate hikes, in a move that analysts could announce greater gains for the U.S. currency in 2022.
A 0.7 percent rise for the dollar brought it above 116 yen for the first time since early 2017. The rises are a sign that fears about the Omicron coronavirus variant are ebbing in markets, prompting traders to focus on the prospects for monetary policy in the US and elsewhere, according to Lee Hardman, a currency analyst at MUFG.
“The scaling down of fears about Omicron disruption to the world economy has encouraged market participants to refocus on the prospect of major central bank tightening policies in the coming year,” Hardman said. As the Bank of Japan is widely expected to halt rates for the foreseeable future, it is “not surprising” to see a rise in US bond yields this week push the dollar up against the yen, he added.
The euro also lost ground against the dollar in the first days of the new year, falling 0.8 percent to $ 1,128, although it remains above its November low of just under $ 1.12.
Data from the Commodity Futures Trading Commission show that investors are positioned for further gains for the dollar against both the euro and the yen – a contrast to the market consensus for much of 2021, when there were significant bets against the dollar.
“The market has completely changed its mind,” says Jane Foley, head of currency strategy at Rabobank. “People were caught short when the Fed kicked off the conversation about 2022 rate hikes in June, and that reversal was fixed in December.”
US Federal Reserve officials indicated at their policy meeting last month that they expect to increase rates three times this year, in an effort to tame high inflation. A sell-off in US government bonds Monday, which pushed US two-year treasury yields to their highest level since the start of the pandemic, suggested investors come to the same view – with about three increases for 2022.
Given the pace of U.S. inflation, which shot to a 30-year high in November, the Fed may finally move faster – further strengthening the dollar – according to Athanasios Vamvakidis, head of G10 foreign exchange strategy at Bank of America.
“We think the market price is not enough for the Fed,” he said. “Global growth usually means a weaker dollar, but instead we have this unequal recovery and overheating of the US economy.”
So far, the prospect of higher borrowing costs has done nothing to derail the surge in risky assets such as equities. But if that happens, nervous investors are likely to flee to the relative safety of the dollar, Vamvakidis said. “This is not our base case, but a risk-off move means even more upside for the dollar,” he added.
Although the rise in inflation has also affected economies outside the US – particularly the euro area – a lower starting point and a record slower price increase mean that the European Central Bank is likely to tighten policy more slowly, investors say.
“Other central banks around the world are unlikely to be able to match the tightening of the Federal Reserve,” said Jonathan Baltora, head of FX at Axa Investment Managers. “Inflation is just a much bigger problem in the US – it’s just the UK that might be facing something similar.”