FX Market Update: US Dollar Index Surges After Fed Decision

The US dollar index rises after Fed

The US dollar jumped against most currencies after the last Federal Reserve interest rate decision of the year. In it, the committee decided to leave interest rates unchanged as most analysts were predicting. It also changed its view on inflation, which it hopes will remain elevated for a while.

The bank indirectly expressed concerns about some of Donald Trump’s policies, which it sees as being inflationary. For example, Trump has pledged to restart his trade war with top trading partners like China, Canada, and Mexico. Tariffs on goods from these countries will be passed on to consumers, leading to higher prices.

Trump has also proposed to carry out deportations, which will lead to higher cost of doing business for companies in industries like real estate and hotels. Therefore, the Fed lowered its interest rate cuts expectations for 2025 from four to just two.

Euro crashes amid political issues

The EUR/USD and EUR/GBP pairs continued their downward trend as concerns about key European countries continued. The German government has collapsed as the country goes through a recession and widening budget deficit. Some of the top companies in the country have announced large layoffs.

France, the second-biggest economy in Europe, is also struggling this year. Other countries are also seeing a strong slowdown. Therefore, the European Central Bank (ECB) has embraced a more dovish tone as it slashed rates four times. It has also hinted that it will deliver several cuts in 2025 in a bid to support the ailing economy.

Brazilian real rebounds after central bank intervention

The Brazilian real has been in a strong downtrend and moved to a record low last week. The USD/BRL exchange rate rose to a record high of 6.3125 and then softened to 6.10 after the central bank intervened by pumping $17 billion in the market. It also rebounded after President Lula da Silva hinted that the government would focus on deficit reduction.

The currency has been in a freefall amid concerns that the economy was overheating, which could lead to a hard landing. This strong growth has been because of more government spending, which has led to a widening trade deficit.

The central bank has embraced policies to support the currency. For example, it has delivered several interest rate hikes this year even as other central banks hiked rates. It hiked rates by 1% in its last meeting, bringing the benchmark rate to 12.25%. It also hinted that it would hike 14.25% to fight the elevated inflation.

Canadian dollar plummets as political uncertainty continues

The Canadian dollar has been in a strong downward trend this year. The USD/CAD pair soared to a high of 1.4462, its highest level since March 2020. It has soared by almost 20% from its lowest level in 2020.

This crash happened as the Bank of Canada (BoC) slashed interest rates more than other central banks this year. It has cut rates four times, and analysts expect that the trend will continue into 2025.

The Canadian dollar has also retreated as the price of crude oil continued falling. Brent and West Texas Intermediate (WTI) have dropped by over 15% this year. This is notable because Canada is the fourth-biggest oil producer in the world.

The USD/CAD pair has jumped because of the ongoing trade tensions between the United States and Canada. Trump has vowed to impose more tariffs on Canadian goods, a move that could affect trade between the two countries.

Additionally, there are concerns that Justin Trudeau will not last as the country’s prime minister for a while. All these factors have become the perfect storm. In a note, analysts at ING said:

Should we see a de-escalation in the Trump-Canada trade spat, we expect USD/CAD to slip back to the 1.40 area, and even below if the Bank of Canada halts easing earlier than expected.

ING Analysts

Turkish lira crash accelerates

The USD/TRY exchange rate continued soaring, reaching an all-time high of 35 ahead of Thursday's upcoming Turkish central bank decision.

The CBRT will likely leave interest rates unchanged at 50% as inflation has remained stubbornly high this year. Recent data showed that the headline Consumer Price Index (CPI) dropped from 48.58% in October to 47.09% in December, higher than the median estimate of 46.60%.

Turkey’s inflation has remained higher than expected, and a rate cut may worsen the situation in the coming months. Therefore, the bank will likely hold rates steady this week.

Low volume in the forex market this week

The forex market will largely be muted as most traders and investors will be on holiday. There will be no major economic data and interest rate decisions to watch this week. Therefore, market participants will largely be focusing on the last week’s interest rate decisions by central banks like the Federal Reserve, Bank of England, Norges Bank, and Riksbank.