The Dollar flexes its muscles

The US dollar flexed its muscles last Friday, extending its rally by 0.5% to hit 102.50, fueled by a red-hot September nonfarm payroll report and rising geopolitical tensions in the Middle East. The greenback made broad-based gains against G10 currencies, reminding traders who's boss. The US labor market once again proved its resilience, with 254,000 jobs added in September, smashing through the 150k Bloomberg consensus and dwarfing August's 142k figure. The unemployment rate ticked down to 4.1% from 4.2%, while average hourly earnings held steady at 0.4% month-on-month, beating market expectations of 0.3%. On a year-over-year basis, wages surged 4%, up from August's 3.8% and above market predictions.

As a result, the market swiftly ditched the odds of a hefty 50bps rate cut in November. Traders are now only pricing in a modest 25bps trim, with expectations of another 25bps cut in December—potentially bringing the Fed funds rate to 4.50%-4.75% by the end of 2024. The dollar's strength was further amplified as risk-off sentiment gripped markets, thanks to heightened tensions in the Middle East.

Speaking of which, Brent crude had a stellar run, surging more than 8% to close the week at $78.05 per barrel. With no signs of de-escalation in sight, oil markets are bracing for further volatility. A sustained oil price spike is a ticking time bomb for many Asian economies, especially those heavily reliant on imports. Japan, South Korea, and India stand in the crosshairs, as their terms of trade will take a serious hit, likely adding fresh downside pressure to their currencies.

In Japan, traders are unwinding their long USDJPY hedges as the yen catches some temporary relief, thanks to chatter around the new Prime Minister’s stimulus package potentially jumpstarting growth and keeping deflation at bay. However, the yen’s trajectory remains uncertain, with the market laser-focused on how the Middle East oil shock unfolds and where the Fed’s rate cut path ultimately leads. Still, don't sleep on Japan’s fiscal firepower—should a sizeable stimulus package hit the wires, the odds for a December BoJ rate hike could spike dramatically, catching the market off-guard as many have written off any near-term tightening.

If you liked the long yen play at 146-47 on Friday, riding the stimulus whispers, you should love it at 148-149—especially as we inch closer to the critical 150-152 resistance zone, which could very well be the line in the sand for BoJ policymakers. So, with stimulus leading to rate hike fever and the possible BoJ currency backstop, the risk-reward ratio of long JPY looks a lot more attractive. But caution still reigns on a possible oil price shock. Not the most straightforward 250-pip trade in the game

On the broader front, Asian currencies weakened against the surging dollar. The region’s dependence on oil imports, especially in economies with limited domestic production, exposes them to oil price shocks. As markets opened with a relatively light calendar this week, eyes are on Thailand's September inflation print. Annual headline inflation is expected to rise to 0.8%, up from August’s reading, but still below the country’s inflation target range of 1% to 3%. Since April last year, inflation has consistently undershot that lower band, with only a brief exception in May.

Thailand’s central bank is holding its ground, resisting government calls to slash rates, as both the finance minister and the central bank governor gear up for another meeting later this month to reassess the inflation target. For now, markets are watching closely to see if policy will finally bend under mounting pressure.