Analysis-Dollar's rally supercharged by diverging US rate outlook

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The U.S. dollar index is up 4.6% this year and stands near its highest levels since early November. Market participants grow convinced the Fed will need to leave interest rates at current levels for longer to avoid a potential resurgence of inflation. Investors late Friday were pricing in just 50 basis points of interest rate cuts in 2024, compared to 150 basis points priced in at the start of the year. Some global central banks could have a freer hand to ease monetary policy, including the European Central Bank, the Bank of Canada, and Sweden's Riksbank. Yield differentials between the U.S. and other economies have widened, contributing to the greenback’s rally. Bullish investors have increased their bets on the dollar, while bears have wavered. Central bank policy has diverged, reflecting economies' varying struggles to contain inflation. The dollar could continue appreciating broadly on the back of a more hawkish Fed relative to the ECB. A stronger dollar could complicate the inflation fight for other economies as it pushes down their currencies. Dollar strength can also be a headwind for U.S. multinationals as it makes it more expensive to convert their foreign profits into dollars. The U.S. currency is a popular destination for investors during times of geopolitical uncertainty. The dollar may receive a boost from the Fed allowing assets to run off its balance sheet. Some analysts believe the dollar has more room to run, while others are less certain.

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