The market is pricing in five Fed interest rate cuts next year, and the dollar bear market is coming?

The dollar has been trading lower since September and has now fallen to a four-month low, with the yen, euro and yuan supported by expectations of a Fed rate cut next year, which has been rising for nearly two months.

As the U.S. economy gradually cools down according to the Fed's expected trajectory, and the market's expectations for the Fed to cut interest rates next year have increased significantly, many analysts believe that the U.S. dollar's bull market in the past few years may be coming to an end.

Markets are starting to imagine that the Fed will cut interest rates five times next year

Considering that the US CPI and PPI both fell more than expected in November, coupled with a series of weaker-than-expected economic data, the market is increasingly convinced that the Fed has ended its year-long interest rate hike cycle.

According to the CME Fed Watch tool, futures traders expect a 97.5% probability of no rate hike in December, which is almost a certainty.

Traders also expect the Fed to open the door to rate cuts as early as March next year. At present, expectations for the level of interest rates at the end of next year are more concentrated in the range of 4%-4.35%, that is, 1.25 percentage points of interest rate cuts, and each rate cut is 25 basis points, which is equivalent to five rate cuts.

And within the Fed, the dovish cry is getting louder.

Fed Governor Waller, a big hawk, said last week that if inflation can continue to move lower, it can start lowering policy rates. Atlanta Fed President Bostic and Cleveland Fed President Mester both supported a December move, with the latter being a hawkish official in the traditional sense.

Is the dollar bull market coming to an end?

Currently, in Wall Street's annual FX outlook, there is an endless stream of bearish dollar forecasts and rhetoric.

ING believes that the dollar's rally will eventually stop in 2024, and the Federal Reserve will cut interest rates to less restrictive areas in order to fulfill its dual mission of fighting inflation and maximizing employment.

Goldman Sachs expects the outlook for the dollar next year to be bleak, but a strong U.S. economy and high yields are likely to support it.

Richard Franulovich, head of foreign exchange strategy at Westpac, said in a recent interview with foreign media that the "mini" bear market trend of the US dollar may continue further.

However, some analysts believe that it may be too early to assert the end of the dollar bull market.

Asset manager T Rowe Price pointed out that the current bets on the Fed to cut interest rates next year are a bit overblown, and it is expected that the growth rate and higher interest rates in the United States relative to other major economies will still support the dollar.

Where will non-US currencies go next year?

While the dollar is teetering, the yuan, euro and yen have continued to recover in recent days.

In November, the offshore yuan rose 2.70% against the US dollar, the euro rose by 2.95% against the US dollar, and the Japanese yen rose by 2.27%.

With the prospect of the Fed cutting interest rates, where will these non-US currencies go in the coming year?

In Europe, while ECB President Christine Lagarde continues to pour cold water on expectations of rate cuts, money markets are pricing in an 84% chance of a 25 basis point rate cut by the ECB in March, up from 72% predicted on Monday.

This means that if the ECB starts cutting interest rates next year, the euro may be weaker relative to the dollar as a whole, and weak economic growth and geopolitical tensions in Europe will also limit the upside of the euro.

In China, analysts at Soochow Securities Shao Xiang and Tao Chuan believe that under the prospect of the rise of the "policy bottom" attribute, the deepening of the brand of "financing currency" and the weakening of the function of "economic stabilizer", the RMB exchange rate is very likely to break 7 next year.

Looking at Japan, although the economy is still in a situation of "domestic and foreign difficulties", the central bank's withdrawal from the negative interest rate policy seems to be a foregone conclusion.

In a report released last month, Nomura expected that the Bank of Japan would lift its yield curve control (YCC) policy in April next year and end negative interest rates in the third quarter.

However, the current bearish atmosphere in the market is strong, and hedge funds increased their bearish bets on the yen last week, the highest since April 2022. The market believes that the absolute difference in yields between Japan and major economies such as the United States is still large, which is negative for the yen.

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