Dollar outlook as inflation cooled while growth remained resilient.
By Izzy | Economist & Executive Director, Global Finance Institute
The year 2023 tested the Federal Reserve’s credibility as it sought to engineer what markets called the “soft landing” — disinflation without a deep recession. After the blistering pace of hikes in 2022, the Fed slowed to smaller increments, lifting the federal funds rate to 5.25–5.50% by July, then holding steady through year-end. For the dollar, the narrative shifted: no longer driven purely by rate differentials, but by whether disinflation would stick without growth collapsing.
The Slower Pace of Tightening
From March 2022 to May 2023, the Fed delivered 10 consecutive hikes. But by midyear, with inflation trending lower, officials paused. Markets debated whether the Fed was done or preparing for a second leg of tightening. The “higher-for-longer” mantra kept U.S. yields elevated, supporting the greenback.
MoM and YoY Indicators: Signs of Cooling
- Inflation: Headline CPI slowed from 6.5% YoY in December 2022 to 3.1% by December 2023. MoM prints averaged 0.2%, indicating steady disinflation. Core PCE, however, remained sticky near 3.4% YoY.
- Employment: Payroll growth moderated to ~200k per month. Unemployment edged up slightly to 3.7–3.9% by year-end, still near historic lows. Labor force participation improved modestly, easing wage pressures.
- Wages: Average hourly earnings cooled to 4.1% YoY in December, down from 5.7% a year earlier.
- External Indicators: NOAA reported 28 separate billion-dollar climate disasters, the most on record, adding fiscal strain and insurance shocks. FBI data suggested overall violent crime trended lower, though property crime saw a small YoY uptick.
These MoM and YoY metrics gave the Fed cover to pause while reinforcing that policy needed to stay restrictive.
Dollar Performance
The dollar remained elevated but showed more two-way volatility. The DXY began the year around 103, fell below 100 in July as markets priced in Fed cuts, then rebounded to ~104 by year-end as data proved resilient.
Key FX moves included:
- EUR/USD: Strengthened in H1 on disinflation optimism, then weakened in H2 as U.S. data outperformed.
- USD/JPY: Stayed above 140 as the Bank of Japan maintained yield-curve control.
- EM FX: Benefited from dollar weakness midyear, only to retrace as the Fed stuck to its hawkish hold.
Market Sentiment
For traders, 2023 was about reconciling two narratives:
- Disinflation data pointed to relief. CPI and wage growth slowed steadily.
- Resilient growth complicated the picture. GDP expanded 2.4% YoY, defying recession forecasts.
The combination allowed the Fed to pause without panic — but also prevented the dollar from weakening sharply.
Lessons for Traders
The 2023 cycle showed that:
- MoM data trends outweighed single prints in shaping Fed policy.
- External shocks, particularly climate disasters, added fiscal and inflation noise.
- The dollar no longer traded only on hikes, but on the credibility of disinflation.
For forex traders, the dollar’s resilience in 2023 underscored its dual role: supported by higher yields, yet capped by markets betting on eventual easing.
