Dollar Flat as Relentless Rally Takes a Breather

September 26, 2023
  • U.S. yields continue to rise after last week’s FOMC decision; Moody’s warned of the repercussions of a possible government shutdown; Fed hawks remain vocal; the U.S. curve remains inverted, but less so; August Chicago Fed NAI is worth discussing; Brazil reports mid-September IPCA inflation
  • ECB officials are acknowledging the economic slowdown; Schnabel downplayed the current contraction in money supply; National Bank of Hungary meets
  • Jawboning has picked up again as the yen continues to weaken; polls suggest opposition National Party would need the support of two smaller parties to form a government; an Evergrande unit missed a local bond payment

The dollar is flat as the relentless rally takes a breather. DXY is trading flat near 106 after making a new cycle high near 106.204 earlier today. Next up is the November 30 high near 107.195. The euro is trading flat near $1.06 after trading near $1.0570, the weakest since March 16, and is on its way to testing that month's low near $1.0515. Break below would set up a test of the November 30 low near $1.0290. Sterling is trading lower near $1.2185, the weakest since March 20 and is on its way to testing that month's low near $1.1805. USD/JPY trade near 149.20 today, the highest since October 24, before some official jawboning pushed it back below 149. The pair is on its way to testing that month's high near 152. The fundamental story remains in favor of the greenback as the U.S. economy is in a much stronger position than the other major economies such as the eurozone or the U.K. With firm U.S. data expected to lead to an adjustment higher in Fed tightening expectations, this should feed into further dollar strength.


U.S. yields continue to rise after last week’s FOMC decision. The rates market is finally believing the Fed’s message of higher for longer. The 10-year yield traded near 3.72% July 19 and traded near 4.56% today, while the 30-year yield traded near 3.83% July 19 and traded near 4.68% today. Of note, the real 10-year yield traded near 2.17% yesterday, another cycle high. The FX market has taken its cue from the rates market and continues to take the dollar higher, as DXY bottomed July 14 and has risen 6.5% since. Indeed, DXY has gained every week since that bottom for a streak of ten straight. These trends should continue.

Moody’s warned of the repercussions of a possible government shutdown. The agency wrote “While government debt service payments would not be impacted and a short-lived shutdown would be unlikely to disrupt the economy, it would underscore the weakness of US institutional and governance strength relative to other Aaa-rated sovereigns that we have highlighted in recent years.” Moody’s added that “a government shutdown would demonstrate the significant constraints that intensifying political polarization continue to put on US fiscal policymaking during a period of declining fiscal strength, driven by persistent fiscal deficits and deteriorating debt affordability.” After Fitch downgraded the U.S. to AA+ back in August, Moody’s is now the only major rating agency to maintain its top rating for the U.S.

Yields were already at the highs of the day before the Moody’s headlines hit so we’re not sure there would be much market impact from another downgrade. That said, the risks keep piling up. We haven't been writing about a likely government shutdown because quite frankly, we always try to look through these shutdowns as they typically have no lasting impact on the economic outlook. However, the risk of another shutdown reflects a growing problem of governance for a country that appears to be getting more and more polarized. Rather than focusing on debt servicing capabilities, it’s clear that this political dysfunction is what Moody's and Fitch are truly focusing on as the bigger risks to the U.S. rating.

There is also scope for a near-term impact as a shutdown would prevent government data collection and so some data releases could be delayed. Our understanding is that data from the Fed would not be impacted and weekly jobless claims would still be reported. However, if key September inflation data due out in October before the November 1 decision are delayed, this could push the Fed into another hold then. Again, this speaks of the potential economic impact of a dysfunctional political system.

Fed hawks remain vocal. Yesterday, Kashkari said that “If the economy is fundamentally much stronger than we realized, on the margin that would tell me rates probably have to go a little bit higher and then be held higher for longer to cool things off.” He is a voter on the FOMC this year and admitted that he is one of the twelve Fed policymakers looking for one more hike this year in the Dot Plots. Yet Fed tightening expectations remain restrained. WIRP suggests only 20% odds of a hike November 1, rising to 45% December 13 and 50% January 31. These odds are way too low given the Fed’s hawkish stance and should move higher if the data remain firm, as we expect. Fed officials are likely to push the higher for longer narrative this week. Bowman speaks today.

The US curve remains inverted, but less so. The 3-month to 10-year curve at -87 bp is the least inverted since early March, while the 2- to 10-year curve at -61 bp is the least inverted since mid-May. Of course, virtually all of this move in the curve has come at the long end. Unlike some optimists, we have not discarded curve inversion as a recession indicator. However, the US economy remains robust and so a recession has likely been pushed out to 2024.

August Chicago Fed National Activity Index is worth discussing. The headline came in at -0.16 vs. +0.15 expected, while July was revised to 0.07 vs. 0.12 previously. The 3-month moving average rose slightly to -0.14 vs. -0.15 in July. This is the highest since March and moves further away from the -0.7 that signals recession. This series has taken on greater significance given that the 3-month to 10-year curve remains deeply inverted. The continued resilience in the economy is noteworthy and suggests the Fed still has more work to do in getting to the desired sub-trend growth.

Regional Fed surveys for September will continue rolling out. Philly Fed non-manufacturing survey, Richmond Fed manufacturing (-7 expected) and business conditions surveys, and Dallas Fed services index will all be reported. Yesterday, Dallas Fed manufacturing survey came in at -18.0 vs. -14.0 expected and -17.2 in August

Housing data will remain in focus. July FIFA and S&P CoreLogic house prices and August new home sales will be reported. Sales are expected at -2.2% m/m vs. 4.4% in July. Pending home sales will be reported Thursday and are expected at -1.0% m/m vs. 0.9% in July. With the average 30-year mortgage rate moving higher to a cycle high around 7.75% and likely to keep rising, the housing sector is likely to show further signs of weakness.

We get some confidence measures. September Conference Board consumer confidence will be reported today. Headline is expected at 105.5 vs. 106.1 in August. If so, it would be the second straight monthly drop from the 114 peak in July. Final September University of Michigan consumer sentiment will be reported Friday.

Brazil reports mid-September IPCA inflation. Headline is expected at 5.02% y/y vs. 4.24% in mid-August. If so, it would be the highest since mid-March and above the 1.75-4.75% target range. However, this is due in large part to low base effects and should wear off in Q4. The central bank also releases its minutes today. At last week’s meeting, the bank cut rates 50 bp, as expected, and signaled a steady pace of easing ahead. Next meeting is November 1 and another 50 bp cut to 12.25% is expected. The central bank then releases its quarterly inflation report Thursday.


ECB officials are acknowledging the economic slowdown. Muller reiterated that he’s not expecting any more rate hikes as things stand and added that “Right now, we see that the economic situation is relatively weak in the euro area as a whole. Looking forward, it could start improving slightly. If the recovery is slower, then that means smaller pressures in terms of inflation.” Yesterday, Lagarde said data point to further weakness in Q3 but added that the ECB is not talking about rate cuts, while Schnabel noted “Activity in the euro area economy is clearly moderating.” Lane, Simkus, and Holzmann also speak today.

Schnabel downplayed the current contraction in money supply. She said “The current, unusual contraction in monetary aggregates is unlikely to foreshadow a deep recession but rather reflects a significant rebalancing of portfolios after a long period of low interest rates.” Eurozone reports August M3 data tomorrow and is expected at -1.0% y/y vs. -0.4% in July. If so, this would be the weakest on record dating back to 1971. There is no doubt that the eurozone is going into recession; the only thing that’s unknown is how bad it will be.

Despite a few hawkish holdouts, the discussion at the ECB has clearly shifted from how high to how long. WIRP suggests around 5% odds of a hike October 26, then rising to top out near 20% December 14. The first cut is still seen around mid-2024 but has tilted towards June 6 recently vs. July 18 previously..

National Bank of Hungary meets. It is expected to keep the base rate steady at 13.0% whilst cutting the 1-day deposit rate 100 bp to 13.0%. With the two rates united, the bank is likely to cut both of them monthly going forward. The swaps market is pricing in 175 bp of easing over the next six months followed by another 175 bp over the subsequent three months. Such an aggressive pace of easing would surely keep the forint under pressure.


Jawboning has picked up again as the yen continues to weaken after Bank of Japan’s dovish hold last week. USD/JPY traded above 149 briefly for the first time since October 25, right around the level where the BOJ intervened that month. Right on cue, Finance Minister Suzuki said “As I said at the morning press conference, I’m watching market trends with a high sense of urgency.” Fear of FX intervention is likely to slow the move higher but until the monetary policy divergence narrows, there's only one way for USD/JPY to go and that's up. Of note, WIRP suggests 70% odds of liftoff in December, rising to nearly 75% in January and fully priced in for March. The minutes of the July 27-28 BOJ meeting will be released tomorrow.

Polls suggest current opposition National Party would need the support of two smaller parties to form a government. Latest poll from Newshub-Reid Research showed support for National fell 1.8 percentage points to 39.1% while support for Labour fell 0.3 points to 26.5%. If these numbers hold up, National would need the support of right-wing ACT Party with 8.8% support and the nationalist New Zealand First Party with 5.2% in order to form a majority bloc in parliament. New Zealand First needs 5% of the vote in order to regain parliamentary representation and it’s going to be a close call. Reports suggest ACT leader Seymour and New Zealand First leader Peters do not get along. Elections will be held October 14.

An Evergrande unit missed a local bond payment. Subsidiary Hengda Real Estate Group defaulted on CNY4 bln ($547 mln) in principal and interest payments due September 25. The company said it would “actively” negotiate with bondholders to find a solution. However, it has been unable to meet regulator qualifications to issue new bonds and so it cannot proceed with any of its planned restructuring that would have creditors swap defaulted bonds for new ones. Renewed focus on woes in the property sector has led to a nearly 8% drop in iron ore prices since the mid-September peak and this has weighed on AUD.

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