USD Continues Its Descent Despite Little Impulse From Equities

The USD sell-off continues this morning, unusually without the helping hand of a “risk on” backdrop.

Broadly speaking, equity markets are flat this morning, held back by company-specific concerns rather than a change in macroeconomic conditions. The focus remains on the optimistic view that the battle against inflation can be won without major damage to the global economy. A US interest rate cut by June 2024 is now 80% priced in.

CME FedWatch Tool

Source: (CME)

A rate cut by March is seen as a 1:3 possibility. In a holiday-shortened week in the US, the schedule is manageable. It is unlikely that the “soft landing" will be challenged for now, which could explain why USD bears remain so confident. The notable winner has been the JPY, likely reflecting a partial unwinding of overextended positioning, but the GBP and EUR may also hope for some local support this week with UK tax cuts on the horizon and preliminary PMIs offering scope for improvement after the misery of recent months. For now, USD selling continues.

GBP-USD again tried to hold above 1.25, despite the media hinting at possible tax cuts over the weekend. The British Chancellor of the Exchequer Hunt will deliver his autumn Budget today/tomorrow. In interviews over the weekend, he emphasized the need to reduce the tax burden in a responsible way without jeopardizing progress in reducing inflation.

Prime Minister Sunak yesterday morning. At the center of the political debate is the question of which taxes should be reduced. In the press over the weekend, company tax, inheritance tax, national insurance and income tax were mentioned as possible measures. For sterling, the impact of fiscal stimulus is likely to be positive at this stage, especially if the Chancellor manages to get the message across as "pro-growth" without being "pro-inflation" at the same time.

The risk of a repeat of last year’s market turbulence in connection with the autumn statement is low. Nevertheless, the fact that GBP-USD has been unable to hold above the 1.25 level indicates some fatigue in the recovery and I continue to believe that the rate will ultimately fall.

The ECB's rhetoric this morning allows interesting conclusions to be drawn about the general “soft landing” narrative.

Wunsch from the ECB, one of the most aggressive voices, espoused the following logic this morning. “Is it a problem if everyone thinks we are going to cut rates. Then we will have a less restrictive monetary policy… And I’m not sure it will be restrictive enough. So, it increases the risk that you must correct in the other direction.” (Bloomberg)

HSBC economists do not expect further rate hikes, but they do expect the Fed, ECB and BoE rate cuts to come much later than the market has priced in. The rhetoric from all three central banks continues to signal a strategy of "keeping rates high", which the markets are ignoring and instead expecting a sequence of rate cuts that supports the “Goldilocks" view. But perhaps the inflation temperature will not be cool enough by 2024 to fulfil these expectations.

NZD-USD rose overnight along with other “risk appetite” currencies as market risk appetite increases.

While the cyclical NZD was also one of the G10 best performing MTD currencies, I see increasing challenges for the NZD going forward, both externally and internally. Externally, I expect a return of the USD-supportive macroeconomic environment, with markets too quickly pricing in a “Goldilocks" sequence of rate cuts in the G10. In addition, historically low growth in Chinese demand for dairy products and the ongoing crisis in the Chinese property sector are likely to weigh on the NZD. I believe that the NZD’s carry advantage is probably only a matter of time as forward-looking indicators continue to send disinflationary signals. In addition, a faster transmission of monetary tightening in New Zealand compared to the US should lead to a convergence in the rate cut outlook between the RBNZ and the Fed. The markets are currently expecting the RBNZ to cut rates by around 40 basis points next year, compared to 90 basis points from the Fed.

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