November 13, 2023 | 3 MIN READ

Weekly Market Update

As Goes the Fed, So Goes the Dollar

What happened last week?

  • The S&P 500 rose 1.31%
  • The Dow Jones gained 0.65%
  • The Nasdaq advanced 2.37%

Investors are often surprised to learn the Fed typically shifts from raising rates to lowering them while the economy is still creating jobs. The Fed needs to work with long lead times.

We expect the Fed will cut rates more aggressively than its developed country central bank peers in 2024. If this indeed happens, it should support a softer US dollar ahead and a broadening opportunity set for investors.

3 Things to Know

Inflation Is Coming Down Across the World

After reaching a global peak of 8.7% in 2022, the rate of inflation is coming down across the world.

While inflation has not reached the 2% target, we have a high level of confidence that core inflation measures will slow in the coming year.

Routinely lagging components of the CPI are only beginning to moderate. Even in the rapidly growing services sector, wage growth is slowing.

It is not in the Fed’s interest to wait to lower rates until a major recession is underway. To avoid a recession in 2024 requires that the Fed not keep monetary conditions too tight for too long and to recognize that its tools operate with a long lag.

Interest rate changes do not fully impact the economy for 12–18 months. So, the Fed must anticipate changes to the economic outlook well ahead of time and set monetary policy parameters accordingly.

Waiting until economic data signals an economic contraction is likely too late for the Fed to act if the goal is not to induce a recession. Historically, the Fed has begun easing when the US economy has looked much like it does today.

The ability to avoid a recession in 2024 therefore, would likely depend on

  1. The Fed not over tightening into a slowing economy
  2. Not to align monetary conditions to current economic settings. Changes made by the Fed typically don’t impact the economy for 12–18 months.

So, the Fed must anticipate changes to the economic outlook well ahead of time and set monetary policy parameters accordingly, to avoid major economic consequences later.

What does the US economy look like when the Fed is about to ease? It looks a lot like it does now.

Given the long lags in monetary policy impact, the Fed typically eases when unemployment is still low and inflation still above target. Headline US monthly jobs in the six months before the Fed typically commences easing has averaged +146K jobs.

The recent October 2023 payrolls headline was +150k. Therefore, a rate cut commencing in early 2024 (from the last Fed hike in July 2023) would require the US labor market to weaken further over the coming month.

Two Things Must Occur for the US Dollar to Decline

For a sustained dollar decline, two apparently contradictory events must occur. The Fed will need remain activist and vigilant in lowering rates. And the economy must slow, but not too much.

For the moment, a Fed pause with US bonds trading in a range of 4.5% to 5.0% may prevent the dollar from rising further, but it may not necessarily cause it to decline substantially.

Yet a significant slowing in US employment gains would change the picture for both bonds and currencies.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorraine Schmitt - North America Investment Strategy

See our weekly CIO Strategy Bulletin for more details