FX Daily: Don’t test the Fed
DXY depreciated 0.6% to 108.3, betting on a softer US CPI expected today. Consensus expects headline inflation to slow to 8.1% YoY in August from 8.5% in July. However, excluding food and energy prices, core inflation will rise to 6.1% from 5.9%. Meanwhile, the Dow, S&P 500, and Nasdaq Composite rallied 0.7%, 1.1%, and 1.3% respectively. Investors were encouraged by a New York Fed survey reporting one-year US consumer expectations eased to 5.7% in August from 6.2% in July, and to 2.8% from 3.2% over the next three years. The survey and the divergent expectations for headline and core inflation reflected the optimism from falling gas prices that US Treasury Secretary Janet Yellen had warned may spike again due to the European energy crisis.
The Fed will still consider inflation too high above the 2% target to take its foot off the brakes. Before entering a blackout period this week, Fed officials were leaning towards a 75 bps hike (to 3.25%) at the FOMC meeting on 21 September. The bond market appears to agree. The US Treasury 2Y and 10Y yields are firmer above 3.25% at 3.57% and 3.36% respectively. To appreciate what the Fed meant by “the inflation battle is far from won,” it would be better to look at the New York Fed’s underlying inflation gauge. The last three Fed hike cycles ended when the gauge was near 3%. We remain wary of the Fed lifting next year’s forecast for the Fed Funds Rate above 4% in its Summary of Economic Projections next week.
To guard against complacency, we revised our forecasts last week. Our chief economist now sees the Fed Funds Rate ending the year higher at 4% instead of 3.5% before pausing in 2023. With the US exiting technical recession in 3Q22, and the Eurozone and UK bracing for negative growth in 4Q22, we believe the USD has yet to peak for the year and view the current correction as an opportunity to re-establish longs.
Quote of the day
“If you want peace, you don’t talk to your friends. You talk to your enemies.”
13 September in history
Desmond Tutu led the largest anti-Apartheid march in South Africa in 1993.
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