The Fed is less-hawkish, not dovish

DERBYSHIRE UK, Nov 4, 2023, Week 45. The king dollar has been weakened, as signals from the Fed appear to be less-than-hawkish, which was cemented when a weaker-than-expected US jobs report implied that policy is having the desired effects.

This week, the primary focus will be on the rhetoric of Fed speeches. If Fed members mention the possibility of hikes, we could see treasury yields increase and the dollar rebound. However, if Fed members remain dovish, the dollar could continue to weaken and other currencies could strengthen further.

Chinese economic data releases this week will also be worth watching, as any signs of further slowdown could have a significant impact on global economic growth and currency markets.

Economic events of interest

This shows the market expectations at time of writing, monitor for deviations upon release as these can have significant impacts on market moves.

• Tuesday, October 31st
  • 0300 (GMT) CN Trade Balance: Potentially volatile for USD.
  • 1100 (GMT) EA GDP: Was lower than expected, bearish for EUR.
  • 1100 (GMT) EA CPI: Was lower than expected, bearish for EUR.
• Wednesday, November 1st
  • 1500 (GMT) US Manufacturing PMI: Was lower than expected, bearish for USD.
  • 1500 (GMT) US JOLTS: Was higher than expected, indifferent for USD.
  • 1900 (GMT) Fed Monetary Policy: Was less hawkish than expected, bearish for USD.
• Thursday, November 2nd
  • 0130 (GMT) CN CPI: Potentially volatile for USD.
  • 1300 (GMT) BoE Monetary Policy: Was as expected, indifferent for GBP.
• Friday, November 3rd
  • 1330 (GMT) US NFP: Was lower than expected, bearish for USD.
  • 1330 (GMT) US Unemployment: Was slightly higher than expected, bearish for USD.
  • 1500 (GMT) US Services PMI: Was slightly lower than expected, bearish for USD.
• Monday, November 6th
  • 1515 (GMT) Fed Chair Powell Speech:
• Wednesday, November 8th
  • 1100 (GMT) EA Retail Sales: Higher than previous expected but still contraction, indifferent for EUR.
• Thursday, November 9th
  • 2000 (GMT) Fed Chair Powell Speech:
• Friday, November 10th
  • 0800 (GMT) UK GDP: Lower than previous expected and contraction, bearish for GBP.
  • 1330 (GMT) ECB President Lagarde Speech:
  • 1600 (GMT) US Michigan Consumer Sentiment: Similar to previous expected, indifferent for USD.

Weakening Dollar: Strong economy, dovish Fed

Economy: The US economy grew at its fastest pace in a year and a half in the third quarter of 2023, expanding at an annual rate of 4.9%. This beat market expectations and was driven by a rise in consumer spending and exports. Inflation remained steady at 3.7% in September 2023, defying market expectations of a slight decrease. Energy costs have fallen but moderated due to a rebound in fuel prices. The US economy is expected to continue to grow in the fourth quarter of 2023, but at a slower pace. GDP growth is forecast to be 0.8%, and inflation is expected to moderate to 3.0% by the end of the quarter.

Monetary Policy: The US Federal Reserve (Fed) kept its target interest rate at 5.25%-5.5% in November, for the second time in a row. This indicates that the Fed is focused on bringing inflation back down to 2%, but it also wants to avoid making the economy too weak. The Fed has signalled that this may be the peak of the rate hike cycle, but has left open the possibility of raising rates further.

Technicals: The US dollar fell last week, driven by a softer than expected US jobs report, dovish signals from the Federal Reserve, and a rise in risk appetite among investors. The dollar has short-term support at $104.5 and long-term support at $103.00.

Market Narratives:

• Federal Reserve monetary policy: The Fed's interest rate policy is one of the most important factors affecting the US dollar. When the Fed raises interest rates, the dollar tends to appreciate, as investors are attracted to higher-yielding assets. However, when the Fed cuts interest rates, the dollar tends to depreciate.

• Economic performance: The strength of the US economy is another important factor affecting the dollar. When the US economy is growing strongly, the dollar tends to appreciate, as investors are attracted to the country's economic prospects. However, when the US economy is weak, the dollar tends to depreciate.

• Global risk appetite: The US dollar is often seen as a safe-haven currency, meaning that investors tend to buy dollars when they are risk-averse. As a result, the dollar tends to appreciate when there is uncertainty in the global economy. However, when investors are more risk-tolerant, they tend to sell dollars and buy other currencies.

CME Group 30-Day Fed Fund futures:

• 95% in favour of a hold at the December meeting, up from 79% last week. 

EUR/USD rebounds as US Fed softens and ECB stays hawkish

Economy: The Euro Area economy contracted by 0.1% in the third quarter of 2023, driven by weak domestic demand, high inflation, and tight financing conditions. Inflation declined to 2.9% in October, but remained above the European Central Bank's (ECB) target. Retail sales fell by 1.2% in August, marking the 11th consecutive month of contraction. The unemployment rate increased to 6.5% in September. The ECB expects the Euro Area economy to grow by 0.7% in 2023, 1.0% in 2024, and 1.5% in 2025. However, the outlook is uncertain, as the economy faces a number of headwinds, including high inflation, tighter financing conditions, and subdued foreign demand.

Monetary Policy: The ECB kept interest rates at multi-year highs in October, reflecting a more cautious stance as inflation eases and recession looms. The central bank is likely to maintain its cautious approach in the coming months, while closely monitoring the data.

Technicals:The EUR/USD currency pair rebounded sharply last week, gaining over 2% to close above 1.072. The currency pair had been under pressure in recent weeks, but found support and staged a strong comeback. The rebound was likely due to a combination of factors, including improved investor risk sentiment and a weaker US dollar.

Market narratives:

• US Federal Reserve policy: Weaker-than-expected US jobs growth has reinforced the belief that the Fed is finished with interest rate hikes, which has weakened demand for the dollar and boosted the EUR/USD.

• European Central Bank policy: The ECB has also left interest rates unchanged in recent months, but it has reiterated its commitment to keeping borrowing costs at a restrictive level for some time. This hawkish stance has supported the euro.

• Economic data: Economic data from the eurozone has been mixed in recent months. Inflation has slowed more than expected, but GDP contracted unexpectedly in Q3. This mixed data has kept the euro under pressure.

UK inflation remains high

Economy: The UK economy grew by 0.2% month-over-month in August 2023, reversing from a revised 0.6% contraction in July. The growth was led by the services sector,however the production sector shrank by 0.7%. Inflation remained stable at 6.7% in September 2023, holding at August's 18-month low. Retail sales declined worse than market expectations. The unemployment rate rose to 4.2% in the three months leading up to August 2023. Economists expect the UK economy to grow by 0.1% month-over-month in the fourth quarter of 2023.

Monetary Policy: The Bank of England (BoE) kept its benchmark interest rate at 5.25% in November, the highest level in 15 years. This decision reflects the BoE's difficult task of trying to reduce inflation, which is currently at 6.7%, without causing a recession. The BoE has said that it will likely keep interest rates high for some time in order to bring inflation back down to its 2% target. However, the pace of future rate hikes is uncertain and will depend on economic data.

Technicals: GBP/USD closed the previous week above 1.23 and up 2.5% from the previous week's close with the bulls ultimately taking control. The rebound was likely due to a combination of factors, including improved investor risk sentiment and a weaker US dollar.

Market narratives:

• US Labor Market Slowdown: Data indicating a slowdown in the US labour market supported the belief that the Federal Reserve has reached the end of its tightening cycle. This led to a weakening of the US dollar, which boosted the demand for the pound.

• Bank of England Decision: The Bank of England's decision to keep interest rates stable, while reiterating its commitment to maintaining elevated interest rates for an extended period, was also seen as positive for the pound. This suggests that the central bank is confident in the UK's economic outlook and is willing to support the currency.

• UK Economic Outlook: The Bank of England warned that the economic outlook for the UK remains highly challenging. However, the central bank has significantly revised down its growth outlook, which suggests that it is aware of the risks and is taking steps to mitigate them.