Dollar drops, euro hits more than four-month high

The dollar index was 0.18% lower on the day at 101.44 and the euro was 0.20% higher at $1.1045, the highest since August 10

The dollar index dropped on Tuesday and the euro reached a more than four-month high as investors waited on fresh clues to when the Federal Reserve is likely to begin cutting interest rates as inflation drops closer to the U.S. central bank’s 2% annual target.

Volumes were muted the day after Christmas, however, as markets in the UK, Australia, New Zealand and Hong Kong, among others, were still out for a public holiday.

The dollar is on track to post its worst performance since 2020 against a basket of currencies as expectation of Fed rate cuts dents the appeal of the greenback relative to peers.

Many analysts expect the U.S. economy to markedly slow in 2024, but the Fed is also expected to act to ensure that the gap between the fed funds rate and realized inflation does not broaden too much. If inflation drops much faster than the Fed’s benchmark rate it can tighten monetary conditions more than Fed policymakers intend and raise the risk of a hard economic landing.

Inflation should continue to cool, which will afford policymakers the ability to cut rates by June in order to prevent passive tightening in real rates, analysts at Action Economics noted in a report on Tuesday. However they pushed back against a cut coming in March and disagreed with market pricing of 154 basis points in easing by December, noting that this is "unlikely to be necessary unless the economy were to fall into a recession in coming months."

Data on Friday showed U.S. prices dropped in November for the first in over 3-1/2 years, pushing the annual rise in inflation further below 3%. Annual home prices in October increased again, pointing toward continued recovery of the housing market, data on Tuesday showed.

The dollar index was 0.18% lower on the day at 101.44. It has dropped from a 20-year high of 114.78 on September 28, 2022 and is pace for a yearly loss of 1.98%.

The euro was 0.20% higher at $1.1045, the highest since August 10. The currency has risen from a 20-year low of $0.9528 on September 26, 2022 and is on track for a 3.08% gain this year.

The dollar gained 0.06% against the yen to 142.47. The dollar hit a 32-year high of 151.94 yen on October 24, 2022, and came near this level again last month, before the Japanese currency recovered.