Experts agree: The US Dollar rally migh have come to an end
- The US Dollar Index languishes below 100.00, holding near its lowest levels in the last seven weeks.
- Downbeat US Nonfarm Payrolls data cast further doubts about a September rate hike.
- Bank analysts agree: A weak US CPI reading on Wednesday might give the last blow to the USD.
The US Dollar Index (DXY) consolidates losses, trading below 100.00 at the time of writing on Monday, holding near its lowest levels since mid-June. Growing signs that the US wants a quick end to Iran’s war have removed the risk premium that had been buoying the US Dollar (USD) since February, but domestic issues such as the softer labour market and dwindling hopes of Federal Reserve (Fed) rate hikes are contributing to the downtrend. The US Dollar is showing symptoms suggesting that it is ripe for a correction.
Analysts at ING affirm that “our dovish Fed call is strengthening, and so is our bearish bias on the Dollar.” Despite the market reaction after Friday’s figures, they highlight that “11bp are still priced in for September, 28bp for December and 40bp for April,” and conclude that “there remains ample room for dovish repricing to harm the Dollar if we are right about the Fed.”
Societe Generale: Latest US economic data puts Fed under a different light
In the same line, Societe Generale's experts note that, after “months of obsessing about above-target CPI and PCE inflation, and levelling accusations of being behind the curve,” they argue that the latest “employment situation put the Fed outlook in a different light and raises questions for the direction of the bond and FX markets in 2H.” In this context, they stress that “the DXY must now defend the 200dma at 99.18 to avert a deeper drop.”
BBH strategists observe that, after the Nonfarm Payrolls disappointment, “a soft US CPI print would strengthen the case for a dovish repricing in Fed hike expectations and further undermine USD”. BBH analysts also say that “a hot US CPI print may deliver a knee-jerk USD bounce via higher front-end yields,” but considering that Fed policy is "already restrictive (assuming a neutral rate of 3.00%)," and that the scope for a material hawkish repricing looks limited.”
Commerzbank: The main driver for USD strength has been priced out
Commerzbank observes that, “despite the weak numbers, the correction (of Fed tightening expectations) was moderate,” pointing out that “just roughly six basis points were priced out until the December meeting, meaning a rate hike is still expected by the end of the year.”
They also note that “the USD’s depreciation was also only roughly 0.4%." This means, according to Commerzbank analysts, that there is a “considerable scope for further correction, should the data support it.” In their view, “if this week's inflation figures are also weaker than expected, the payrolls report may have been just another step towards the end for Fed rate hike expectations,” which “would mean that the main driver of the USD's strength over the past few months would be priced out.”
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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