Dollar weakness is mostly due to growing evidence inflation has peaked in the US and the Fed will slow its pace of hikes.
However, the Fed may still head to a terminal rate in the 5% area, if at a slower pace. Additionally, the ECB could soon make a similar slowdown and Euro weakness would boost the USD. Even if the USD has topped, the downside looks limited for now.
Markets are off to a shaky start in what will be shortened week as the US will be closed for Thanksgiving on the 24th November followed by a half session on the 25th which is also Black Friday. It is a seasonally bullish time of year, but often starts with a dip and stocks markets and dollar pairs are following this tendency on Monday. The Dax is –0.6% and US stock futures are lower by around –0.5% ahead of the US open. Meanwhile, the DXY dollar basket is higher across the board as it tries to builds on last week’s reversal and higher close. This has been the largest swing lower in the USD since the uptrend started in early 2021 and it has raised question on whether the trend has finally reversed back down again as the Fed is ready to slow its rate hiking cycle.
The DXY was over –8% from its 2022 peak at last week’s lows, and while it has recovered over +2% over recent sessions, it is still some way from the high and may not reach the previous peak. Yields are also lower, not only in the US, but across many global markets. With the Fed very likely to slow its pace of hikes to 50bps and signs of slowing inflation in the US, there is growing speculation that the dollar has topped.
Dollar pairs have started to look a lot better over recent weeks. GBPUSD may well have bottomed following Kwarteng’s mini-Budget in September and is over +14% from that capitulation low. EURUSD is also showing signs of life and is comfortably back over parity and only held back by the 200dma just over 1.14. The Euro has very heavy weighting in the DXY dollar basket so is important for any sustained turnaround. However, the ECB may well make a similar ‘pivot’ to the Fed pretty soon, and from a much reduced terminal rate. If this were to happen, Euro weakness would boost the DXY significantly.
ECB policy will likely be decided on the state of the eurozone economy over the coming months. Weakness is expected, but as long as there is nothing too concerning, further hikes are likely. One possible hiccup comes from the fact that markets expect and are pricing in a terminal rate of 2.9%, which would require another 150bps of tightening. If the ECB slows to 50bpos in December, and the economy struggles, it is a big ask for a further 100bps. Some analysts such as ING expect only 75bps of further hikes.
“Our team’s view is that the ECB hikes 50bp on 15 December (59bp priced in the markets) and then finishes the cycle with a 25bp hike in February. In other words, we look for the cycle to conclude at 2.25% rather than the 2.90% area priced for the markets in late summer.”
Data is therefore very important and PMIs this week will be watched closely.
As for US data, this month’s CPI drop has practically cemented a top for inflation unless there is a further shock to the system. However, there is still a lot of uncertainty over how quickly it can fall, how the jobs market will act, and whether any of this will affect the terminal rate, which is still expected to be in the 5% area. If we assume rates do reach 5% and inflation stays stubbornly high as it has done in the past, it is unlikely the USW drops much further.
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US Dollar Recovery Underway, But Has It Topped? – Exchange Rates UK
