Sovereign International Daily Market Report
Dollar reverses course, as Fed officials cast doubt over final US rate hike
Highlights:
The rebound in risk assets gathered pace on Tuesday, after communications from FOMC members suggested that another US rate hike was far from guaranteed, while reports emerged that Chinese officials were weighing up the possibility of fresh economic stimulus.
Fed members Jefferson, Logan and Bostic have all poured cold water over the possibility of another US rate increase in the past 48 hours. This has triggered a sharp retreat in Treasury yields (the 10-year note has fallen by 25 basis points in less than a week), and a reversal in the dollar rally. EUR/USD edged back above, while GBP/USD advanced to a near 3-week high, in what were almost entirely dollar centric moves. The distressing news over the weekend out of Israel has so far led to limited safe-haven flows, with the fallout largely centred around the local currency, which has collapsed to 8-year lows. Attention in the FX market now quickly turns to this evening’s FOMC meeting minutes, and Thursday’s US inflation report for September. Both looks set to be key, and elevated volatility is to be expected.
Markets calm bets in favour of further Fed tightening
The clear rationale behind the sell-off in the dollar so far this week has been the retreat in Treasury yields, as dovish Fed communications suggest that the peak in US rates could land lower than investors had previously anticipated. Speaking on Monday, Fed vice chair Jefferson warned that the bank should ‘proceed carefully’ with further interest rate hikes, while fellow member Logan said that higher long-term US yields could limit the need for additional tightening. Atlanta Fed president Bostic struck a similarly dovish tone yesterday, saying that while he didn’t envisage a US recession, he also didn’t anticipate any further rate hikes either.
These remarks support our call that the Fed is already done with hikes, and that the next move in rates will be lower. Markets appear to be coming around to this view, with a final 25bp rate increase now only 30% priced in by futures, down from around 50% following Friday’s steller nonfarm payrolls report.
China stimulus hopes boost investor risk appetite
The euro was helped on its way higher on Tuesday by news out of China, as a report from Bloomberg suggested that authorities were contemplating the issuance of 1 trillion CNY ($137 billion) in debt to boost spending and support the country’s economy. The details of the proposed spending are patchy thus far, though even the mere notion of a greater fiscal injection has been enough to buoy risk assets, particularly those more acutely exposed to global demand. ECB president Lagarde is down to speak on more than one occasion this week, while the latest ECB meeting accounts will also be released on Thursday. Any further hints at an end to the bank’s tightening cycle could weigh on the common currency this week, although room for downside appears limited given current market pricing.
Meanwhile, the pound has edged back towards the dollar, extending its move to around 2% off last week’s lows. Comments from MPC Catherine Mann earlier in the week have provided sterling with a bit of added impetus. Mann expressed concerns on Monday over how long UK inflation would remain above target, while saying that central bankers needed to be more aggressive to achieve their inflation targets. It is worth noting, however, that she is by far the most hawkish member on the rate-setting committee, and most members appear to be favouring a more cautious approach. This generally cautious approach to rates, and the recent deterioration in UK activity data, suggests that outlook for GBP remains far from plain sailing.
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US inflation data, FOMC meeting minutes will now be key
The next couple of days in markets look set to be highly important, and we would expect volatility levels among the major currencies to ratchet up a notch or two during the remainder of the week. The latest FOMC minutes from the bank’s September meeting will be closely watched by market participants this evening. Last month’s ‘dot plot’ showed that most Fed members saw one final US rate hike by year-end, so it will be interesting to see whether the minutes shine any light on how much conviction these hawkish members have in this view.
Thursday’s US inflation data for September will arguably take on even greater significance. Economists are pencilling in a modest easing in price pressures (+0.3% MoM vs. +0.6% in August). A material downside here could take another Fed rate hike almost completely off the table, and would no doubt extent the recent dollar retracement. UK GDP data for August will also be eyed on Thursday morning. A modest rebound in growth seems likely, given the sharp 0.5% contraction in July (+0.2% consensus).
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