Dollar Consolidates but Rally Remains Intact

October 22, 2024

Win Thin

The divergence theme is alive and well; Fed officials remain cautious; regional Fed surveys will continue to roll out
President Lagarde takes the spotlight in a busy line-up of ECB speakers; BOE Governor Bailey speaks
Polls suggest the ruling LDP will do poorly in this weekend’s elections; New Zealand reported mixed September trade data

The dollar is consolidating its recent gains. DXY is trading slightly lower near 103.916 after making a new high for this move near 104.016 yesterday. It is on track to test the July 30 high near 104.799 but looking further ahead, clean break above 103.848 sets up a test of the June 26 high near 106.130. The euro is trading higher near $1.0825 and clean break below $1.0875 sets up a test of the June 26 low near $1.0665. Sterling is trading flat near $1.2985 ahead of Bailey speech (see below) while USD/JPY is trading lower near 150.75 after trading as high as 151.10 earlier today. We believe that recent U.S. data and Fed comments continue to support a very gradual easing cycle. Market easing expectations for the Fed have adjusted after the recent spate of strong U.S. data but are still too dovish. As the Fed repricing continues, the dollar should see another leg higher. In the meantime, soft data and dovish central banks in the rest of the world highlight the ongoing divergences that favor the greenback (see below).

AMERICAS

The divergence theme is alive and well. That should become even clearer after the IMF publishes its October World Economic Outlook later today. The IMF’s updated growth forecasts are expected to show the U.S. economy still outpacing most other major economies. This ongoing economic outperformance remains a major theme underpinning higher Treasury yields and USD strength. In the same vein, the latest edition of The Economist magazine is titled “The envy of the world” in reference to America’s “bigger and better than ever” economy.

Fed officials remain cautious. Logan said, “If the economy evolves as I currently expect, a strategy of gradually lowering the policy rate toward a more normal or neutral level can help manage the risks and achieve our goals.” Kashkari said, “Right now I am forecasting some more modest cuts over the next several quarters to get to something around neutral, but it’s going to depend on the data,” adding that in order to justify a faster pace of easing, he’d need to see “real evidence that the labor market is weakening quickly.” Schmid said, “Absent any major shocks, I am optimistic that we can achieve such a cycle, but I believe it will take a cautious and gradual approach to policy.” Daly said “So far, I haven’t seen any information that would suggest we wouldn’t continue to reduce the interest rate. This is a very tight interest rate for an economy that already is on a path to 2% inflation, and I don’t want to see the labor market go further.” Harker speaks twice today.

Regional Fed surveys will continue to roll out. Philly Fed non-manufacturing survey is expected at 4.1 vs. -6.1 in September. Richmond Fed also reports both its manufacturing and services surveys, with manufacturing expected at -17 vs. -21 in September. Kansas City Fed manufacturing survey will be reported Thursday and is expected to remain steady at -8, while its services will be reported Friday.

EUROPE/MIDDLE EAST/AFRICA

President Lagarde takes the spotlight in a busy line-up of European Central Bank speakers. Lagarde is scheduled to speak twice and is likely to maintain the dovish tone she presented at her post-decision press conference. In our view, the bar for additional ECB easing is low and will be an ongoing drag for EUR. The swaps market is pricing in 150 bp of easing over the next 12 months that would see the policy rate bottom near 1.75% vs. 2.0% at the start of last week. Centeno, Knot, Holzmann, Villeroy, Rehn, and Panetta also speak today.

Bank of England Governor Bailey speaks. He is also scheduled to speak Wednesday, Thursday, and Saturday. In a newspaper interview earlier this month, Bailey held out the prospect of the Bank becoming a “bit more aggressive” in cutting interest rates provided the news on inflation continued to be good. U.K. inflation cooled sharply in September. This raises the risk that Bailey may double down on the dovish rhetoric, leading to a kneejerk drop in GBP. Greene and Breeden also speak today.

National Bank of Hungary is expected to keep rates steady at 6.5%. At the last meeting September 24, the bank cut rates 25 bp to 6.5% and Deputy Governor Virag said “The Monetary Council will continue to make cautious, patient and stability-oriented decisions.” Since then, the forint has weakened and EUR/HUF remains stuck above 400. Last week, Virag said “The MNB may not only pause interest rate cuts in October. If the external environment and inflation outlook justify, the base rate may stay unchanged for a sustained period, raising our interest premium.” The swaps market is pricing in less than 25 bp of total easing over the next 12 months.

ASIA

Polls suggest the ruling Liberal Democratic Party will do poorly in this weekend’s elections. A Kyodo News poll showed only 22.6% backed the LDP and its lead over the opposition narrowing to 8.5 ppt vs. 14 ppt last week. Elsewhere, an Asahi polls showed the LDP will likely lose its majority in the lower house and may not even secure a majority with support from coalition partner Komeito. The only silver lining is that both polls suggest around 40% of the respondents are undecided, meaning they may eventually break towards the LDP. Stay tuned.

New Zealand reported mixed September trade data. The 12-month merchandise trade deficit narrowed to the lowest in 30 months at -NZD-9.1 bln vs. -NZD-9.4 bln in August. Exports rose 3.4% m/m and 5.2% y/y, while imports fell -0.5% m/m and -0.9% y/y. Of note, exports to China, Japan, and Australia all fell y/y while exports to the U.S. and Europe both rose y/y. Solid export growth is encouraging but weak imports suggest domestic demand is softening. Bottom line: the RBNZ has ample room to continue its easing cycle, which is an ongoing drag for NZD. A 0 bp cut November 27 is fully priced in, with nearly 35% odds of a super-jumbo 75 bp move.

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