Written by George Vessey & Boris Kovacevic
Dollar in charge, but recession risks aplenty
The US dollar has climbed to a fresh 11-month high against a basket of currencies overnight, tracking US yields higher after yet more strong economic data bolstered the notion that the Federal Reserve (Fed) will keep interest rates higher for longer. US JOLTS job openings (today) and non-farm payrolls (Friday) could further propel US yields and the USD higher if they surprise to the upside.
Investors welcomed better-than-expected ISM Manufacturing PMI data yesterday, which showed the contraction in the manufacturing sector slowed sharply and price pressures eased. It was a so-called goldilocks report with production picking up, employment rebounding, and prices paid for inputs by factories falling considerably. Hopes of a soft landing are growing, but we’re still of the opinion that a recession is more likely given the many indicators flashing red. The New York Fed’s recession probability indicator is well above 30%, the Conference Board’s US Leading Economic Index has been in negative territory for 15 months and over 50% of US bond yield curves are inverted. The Fed’s survey of senior loan officers at banks latest reading also shows that about half of large and mid-sized banks are imposing tougher criteria for commercial and industrial loans.
Fresh shocks are also emerging, strengthening our recession call, such as auto strikes, student loan repayments, higher oil prices, and a global slowdown. Equities remain under pressure from a strong dollar and surging Treasury yields, with the benchmark 10-year yield topping 4.7%. There is certainly scope for more USD upside in the short-term, but we think that 2024 could spell trouble for the dollar, it’s just a matter of timing the recession and when the Fed starts cutting rates.
Euro under pressure vs. dollar and franc
The euro has fallen to its lowest level yet this year against the backdrop of higher yields in the US and bets that the European Central Bank would cut rates sooner than the Fed next year. Yesterday’s breach of the $1.05 mark puts the currency pair on track to record the 12th consecutive weekly depreciation, having already lost more than 7% of its value since the middle of July. European equities closed lower on Monday after a set of economic data shows that the recession in the manufacturing sector continued into September. EUR/USD is not the only currency pair struggling to regain its charm.
The euro has been below parity against the Swiss franc for 151 consecutive trading days, topping the previous and only record set in 2022. We find that changes in global sentiment, economic data and volatility in bond and commodity markets explain short-term movements of EUR/CHF quite well. However, the long-term descent of the euro has most likely been driven by 1) capital inflows into Swiss financial markets, 2) the Swiss economy growing at a stronger pace than the Eurozone over the past three decades and 3) European government debt levels continuing to rise, causing investors to search for safer alternatives. Upside trends lasting 1-3 years cannot be ruled out given short-term drivers of FX. Longer term, we do expect the 30-year downward trend to continue.
Given the lack of economic data out of Europe, global market drivers will be in charge today. Tomorrow will bring the release of Eurozone retail sales and producer price inflation and speeches from various Governing Council members including Lagarde, Lane and Panetta. The government budget debates in France and Italy will be carefully watched as well.
Pound staggers to 7-month low
GBP/USD has started the new month in the same vein as September. After suffering its worst month in a year, the pound continues to be sold off by investors with GBP/USD falling to near 7-month lows with the key $1.20 level a potential downside target in the short-term.
With UK peak rate expectations climbing beyond 6% earlier this year, the pound benefited from its higher yield appeal, making it the top performing G10 currency for most of 2023. Something changed in July though. Disappointing UK data reignited recession fears and bets on further BoE rate hikes slipped with UK gilt yields. Meanwhile, the resilience of the US economy, alongside hawkish Fed commentary, has seen US yields surge to fresh cycle highs, last witnessed in 2007. The rapid shift in yield differentials, in the dollar’s favour, has resulted in GBP/USD falling over 10 cents from its July peak.
The latest leg lower lacked fresh domestic catalysts other than the fact figures showed that house prices fell across all UK regions for the first time since 2009 in the three months to September. The more pressing concern for sterling and other European currencies is the relentless surge in US yields, but with technical analysis warning GBP/USD is heavily oversold, we feel a correction higher from around these levels is overdue, though the short-term downtrend remains intact.
Euro & pound over 1% lower versus US dollar
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 2-6
Have a question? [email protected]
*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
