The recent comeback may not be indicative of a new broad trend, with FX strategists in a Reuters poll predicting the greenback's path in the next few months suggesting that volatility will dominate currency markets in the short run.
The dollar clawed back all its losses after an eye-popping U.S. non-farm payrolls number on Friday raised doubts about market expectations that the Federal Reserve will loosen monetary policy by the end of 2023, as it fell about 1.5% in January.
The central bank may need to lift borrowing costs higher than previously anticipated, according to Raphael Bostic, Atlanta Federal Reserve Bank president, because of the unexpectedly strong jobs gains in January.
According to interest rate futures pricing, markets are expecting the fed funds rate to peak just above 5.1% by July, which is roughly where the Fed sees it, compared to expectations of less than 5% prior to Friday's jobs report.
That repricing is likely to keep volatility elevated in the near term. The J.P. Morgan VXY G 7 Index is well above its 10 year average.
I think the market is going to be quite fickle and this whole process of the market's view will not be overnight, because I think it will be in line with the Fed's view. Jane Foley, head of FX strategy at Rabobank said that this is a process, and I do think we're going to see some volatility.
There was no consensus among analysts who answered a question on what the greater risk was to the dollar over the next three months.
While 12 said it was that the dollar would decline at a faster speed, 11 said it would decline at a slower speed. The risk was greater with the dollar rising, according to 19 of the 19 who said it was the greater risk.
There's a chance that the dollar will gain a bit in the short run. Brian Rose, senior economist at UBS Global Wealth Management, said that if the data stays good and the Fed gets in at least two more hikes, there is an upside risk to the terminal rate for the Fed.
The consensus view in the Feb. 2 -- 7 poll of 66 forex strategists predicted the dollar to weaken over the next 12 months.
The euro was up 1.5% against the dollar last month, its best start to the year since 2018, and has since given up all of those gains.
The common currency was expected to strengthen from its current level to trade around $1.08, $1.09 and $1.11 in the next three, six and 12 months. The year-end prediction is about 3.5% higher than the $1.07 it was trading on Tuesday.
The Japanese yen was down over 12% last year, its worst performance in nine years, expected to change hands around 124 dollar in a year. If realised, that would be a gain of around 6.5% against the dollar.
The British pound grew from $1.20 to $1.24 in the next 12 months, according to median forecasts.
We still think the dollar will weaken, because there are a number of factors that underpin that view. Brian Daingerfield, head of G 10 currency strategy at NatWest Markets said that we do not think the U.S. economy is likely to continue to slow, but the most recent data we got on Friday pushes us back against that hypothesis.
We think inflation pressure is likely to continue to moderate as we go through the year and that we're seeing less upside risk to the fed funds rate or the fed funds rate as an upside risk to the dollar.