Written by Convera’s Market Insights team
Tail risk of a Fed hike supports the dollar
Boris Kovacevic – Global Macro Strategist
The US dollar started yesterday’s trading session on weak footing and was on track to record the seventh daily fall in a row. This week’s loss of momentum had been caused by government bond yields pausing their multi-month ascent against the backdrop of Fed officials signaling a likely end to the tightening cycle. However, both producer and consumer inflation data surprised to the upside since Wednesday and while markets continue to dismiss the possibility of another rate increase, the tail risk of such a scenario has sharply increased. The current fed funds futures curve suggests a 35% probability of a hike in either December or January with the first cut coming in July 2024.
The repricing higher has been caused by US consumer prices exceeding expectations in September, rising by 0.4% instead of the predicted 0.3%. The annual inflation number therefore stayed at 3.7%, while core inflation fell for a sixth consecutive month to 4.1%. It is important to note that housing costs made up a majority of the overall price increase in September, even though economists expect this component to decelerate in the months to come given the fall of home prices in the last 12 months. However, the fourth increase in producer prices in a row on an annual basis, caused by higher gasoline and food prices, raises the risk of another acceleration of goods inflation. Especially as labour markets remain extremely tight, highlighted yesterday by a report from the Labour Department showing initial claims for state unemployment benefits remaining unchanged at an historically low 209 thousand.
The US Dollar Index made up its losses from the previous four days and is now 1% away from the 10-month high reached last week. The US 10-year government bond yield, sitting at 4.65%, rose following the CPI print but is still on track to record the first weekly fall since the end of August. Retail sales, industrial production, some housing data, and the Fed’s Beige Book are events we will be closely following going into next week. The Greenback has appreciated against 85% of the 50 currencies we follow during the last three months and hedge funds have increased their net long USD position for a third week. Only a sharp deterioration of the US macro data will be able to dethrone the dollar in the weeks to come.
ECB speak overshadowed by US inflation
Ruta Prieskienyte – FX Strategist
The euro surrendered the entirety of its weekly gains after hotter-than-expected US inflation reignited bets of a December rate hike by the Fed. The EUR/USD pair fell to the lower end of $1.05, touching a fresh 7-day low, with little support provided from the European side to cushion the fall.
The minutes released from the ECB’s September meeting on Thursday showed that the decision to hike rates by 25 basis points (bps) to 4.0% was a close call, executed partially to insure against the risk of unanticipated inflation developments. Inflation in the Eurozone continued to decline to 4.3% in September, reaching its lowest level since October 2021. With stagflationary worries in mind, some policymakers are growing in confidence that the past measures have been sufficient to bring inflation down to its 2% target. Nevertheless, uncertainty remained elevated. Policymakers will continue to keep an eye on the worsening state of Italian public finances, which caused a recent bond-market rout in Italy, and an increase of the euro risk premium, defined as the difference between German and Italian interest rates, going forward.
With investors realising rates will remain higher for longer, markets are currently pricing in the first 25bps rate cut in July 2024. With the main upside inflation risks stemming from food and energy prices, the threshold for further rate hikes has been set high. Meanwhile, data out of China this morning helped the euro to a strong start into the European session. Beijing is expected to raise its budget deficit for 2023, which could unleash more than $130 billion of additional debt issuance at a time when economic activity seems to be bottoming. While Chinese exports shrank 6.2% on a yearly basis in September, it was still the second monthly improvement in a row.
Sterling fades ahead of key data next week
George Vessey – Lead FX Strategist
With the UK’s latest GDP data on the softer side, suggesting third quarter GDP fell, coupled with upside surprises in US inflation data this week, the pound snapped a 6-day winning streak and suffered its biggest daily fall this month versus the US dollar. Meanwhile, GBP/EUR moved back to the centre of its 1-month range after struggling to break above its 50-day moving average.
Up until yesterday, the pound’s recent bout of strength was helped by improved global risk appetite as US yields slipped from multi-year highs, prompting investors to take on more risk. The over 4% rebound in the MSCI global stock index in October clearly reflected this. However, a repricing of US interest rate expectations, following the inflation data, has stopped the risk rally in its tracks, supporting the dollar and hurting stocks and sterling. In other news this week, the RICS UK residential market survey house price balance, which measures the gap between the percentage of respondents seeing rises and falls in house prices, fell to a fresh 14-year low as higher borrowing costs continued to weigh on demand and sales volumes. RICS members do see a glimmer of hope that things might be nearing a bottom though as the end of the Bank of England’s (BoE) rate-hiking cycle beckons.
The BoE’s decision will rest mostly on services inflation, wage growth and the job vacancy to unemployment ratio. All of these key data points will be released next week and could determine whether or not the BoE will hike again, which will keep sterling on its toes. Still lingering in the bottom 15% of its 3-month range, but over 1% above its 7-month low, we believe we’ve probably already seen a bottom in GBP/USD, assuming the Fed doesn’t hike again, and US data starts to disappoint from here.
EUR and GBP surrender weekly gains against USD
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 9-13
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*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.
