USD Selling Subsides After Largest Drop in a Year

As we navigate through the final month of 2023, the significant depreciation of the US dollar remains a focal point in the financial landscape. Drawing parallels to the trends observed in November 2022, the current year has witnessed a notable 3.0% drop in the US dollar. In a comparative analysis, the previous year experienced a more pronounced decline of 5.0% in November, followed by a subsequent 2.3% decrease in December. These fluctuations underscore the volatility inherent in the currency markets.

USD Index

Source: Finlogix Chart

Caution is warranted when interpreting recent market dynamics, especially considering the price actions observed last Thursday. Given the context of month-end activities, these movements often exhibit detachment from fundamental backdrops or overarching trends. Nevertheless, it is noteworthy that the dollar corrected modestly stronger, aligning with the upward trajectory of yields in the US.

Delving into seasonal patterns, a compelling trend emerges concerning EUR/USD in December. A retrospective analysis reveals that 14 out of the last 20 Decembers witnessed a higher EUR/USD, boasting an average gain of an impressive 2.6%. Even when excluding the outlier of December 2008 (+10.1%), the average gain over the remaining 13 instances stands at a substantial 2.0%. Further enhancing this pattern, historical data indicates that in 8 out of 11 instances when EUR/USD experienced an upswing in November, it was followed by a subsequent gain in December.

While these seasonal trends offer valuable insights, it is crucial to maintain a balanced perspective that encompasses broader economic fundamentals. The realization of the seasonal bias in December 2023 hinges significantly on the potential deceleration of US economic activity. In the absence of such a slowdown, the optimism among investors spurred by recent declines in inflation may encounter challenges in sustaining momentum. The upcoming release of the jobs report assumes heightened importance as it holds the potential to provide critical cues about the current economic trajectory.

Turning our attention to recent economic indicators, the Beige Book released last week offers insights into the state of the economy. Evidence within the report suggests a notable slowdown, with indications that this trend may manifest more prominently in forthcoming data. A retrospective look at my previous text analysis of the Beige Book underscores the weakest sentiment observed regarding the US consumer since the onset of the 2020 pandemic. Although the sentiment has marginally improved in the current Beige Book, it remains at subdued levels.

The overall sentiment index, amalgamating various key word sentiment indicators, regressed to levels last witnessed in January when inflation exerted a significant influence on sentiment. Furthermore, last week's Beige Book revealed a discernible decline in net sentiment regarding overall "demand" conditions, reaching the lowest level since November of the previous year. The net sentiment concerning housing fell to its lowest point since January this year, and references to the labour market, which had shown improvement in the last four Beige Books, deteriorated sharply to levels last seen in April.

Of particular significance is the downturn in the Labor market, which has historically served as a primary justification for tightening in the latter stages of the economic cycle. If a clearer deterioration in labour market conditions unfolds, it could potentially fuel a further bull steepening of the 2s10s US Treasury curve, a phenomenon that tends to coincide with dollar depreciation. The coming weeks promise to be a critical juncture for assessing the trajectory of the US dollar amidst a backdrop of evolving economic dynamics.

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