The US dollar’s sell-off is looking overdone. DXY bottomed at 105.34 at the start of the US session and rebounded to 106.57, little changed from Monday’s 106.66. The DXY nearly retraced 50% of this year’s rally from 95 to 115. It was near the 105 level when the Fed started pushing back against a dovish pivot in August. After the softer US CPI readings in October, markets had been too fixated on the Fed paving the ground for smaller hikes. The US Treasury 2Y yield is at 4.34%, positioning for a 50 bps hike in the Fed Funds Rate (FFR) to 4.25-4.50%.
However, the Fed is also looking for rates to peak and pause above the 4.6% projected in September. Hence, the Fed cannot be happy with a 10Y yield of 3.77%. The last thing it wants is a long bond yield below the FFR, currently at 3.75-4.00%. Philadelphia Fed President Patrick Harker reminded markets that a 50 bps hike was also significant by historical standards and that the Fed was also tightening monetary policy by winding down its balance sheet by a total USD2.5tn from USD8.6tn. Harker projects US core PCE inflation falling gradually from 4.8% this year to 3.5% in 2023 and still above the 2% target at 2.5% in 2024.
Fed Vice Chair for Supervision Michael Barr told the Senate Banking Committee that the Fed is focused on its responsibility to bring down inflation which it still considered “far too high”. He warned that doing so would significantly slow the US economy and lift the unemployment rate. Atlanta Fed President Raphael Bostic concurred that the FOMC’s top priority was taming inflation despite recession risks. The same message will resonate in the speeches by Fed Presidents John Williams (New York) today and James Bullard (St Louis) tomorrow.
Profit-taking risks should increase ahead of the Thanksgiving holiday next week. EUR’s rally stalled near 1.05, the mid-point of this year’s fall from 1.15 to 1.05. In line with our expectations, GBP tested and retreated from the psychological 1.20 level. USD/JPY is just below 140 and USD/CHF around 0.94, around the levels at the Fed’s Jackson Hole Forum in late August. The same was also seen for USD/SGD, around 1.37. The rally in commodity currencies – AUD and NZD – should peter out if the USD stabilizes and pulls back risk appetite. More so if USD/CNY shows no signs of pushing below the psychological 7 level anytime soon. Expect players to book some profits in the region’s outperformers – KRW and THB.
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