Dollar weakens despite rise in interest rate expectations

NEW YORK (Reuters) - The U.S. dollar fell on Wednesday despite a report of stronger-than-expected inflation data and an increase in interest-rate expectations, raising the possibility that the currency is in a period of secular downturn.

U.S. Dollar banknotes are seen in this photo illustration taken February 12, 2018. REUTERS/Jose Luis Gonzalez/Illustration

“We are in an environment where the dollar is weakening regardless of the move in interest rates,” said Alessio de Longis, a portfolio manager for the global multi-asset group at OppenheimerFunds in New York.

The announcement that the U.S. core Consumer Price Index posted its biggest gain in a year boosted expectations that price pressures may accelerate, prompting a faster pace of interest rate increases from the Federal Reserve. The possibility that the Fed would clamp down on inflation initially drove up the dollar index .DXY.

But the dollar quickly pared those gains, falling to a session low of 88.94 against a basket of currencies, even as traders added to their bets on Fed rate hikes after the inflation report. The dollar was last at 89.032.

U.S. short-term interest-rate futures fell on Wednesday following the inflation report, adding to the conviction the Fed will raise rates twice this year, and increasing the chance of a third rate hike, based on a Reuters analysis of Fed funds futures contracts traded at CME Group.

Analysts disagree on the reasons for the dollar’s fall. De Longis argued that the greenback is in a weakening cycle because of the increased supply of dollars in foreign markets and foreign investors’ overweight positions in U.S. fixed income.

John Doyle, vice president of dealing and trading at Tempus Inc in Washington, was not convinced of a secular downturn. The dollar was the beneficiary of widening interest rate differentials while the Fed was the only major central bank raising rates. But “even though the U.S. Fed is outpacing other central banks, they are no longer the only guest at the policy tightening party,” he said.

In that instance, the dollar’s weakness on Wednesday could be because the riskoff trades that investors put on immediately after the CPI release “have come bouncing back, helped by equity resilience,” said Alan Ruskin, global head of currency strategy at Deutsche Bank in New York.

After opening lower at the bell, the S&P 500 .SPX rose to 2,702.10, its highest since Feb. 7. The Dow Jones Industrial Average .DJI followed the same trend, opening lower before rising 1.2 percent above its last close.

As the dollar weakened, both sterling and the euro recovered. The British pound GBP= was last at $1.40, up nearly 0.7 percent from Tuesday's close.

The single currency EUR= was at $1.245, up half a percent from its last close, supported also by stronger-than-expected euro zone industrial production data for December.

The yen rose to a 15-month high against the dollar at 106.70 JPY= earlier in the day. The Japanese currency was last at 107.03.

Reporting by Kate Duguid; Editing by Andrew Hay and Rosalba O’Brien