Dollar rebounds ahead of PCE data, yen recovers

Dollar trades higher ahead of PCE inflation release

The US dollar rebounded on Wednesday against all but one of the other major currencies, with the pound losing the most after the larger-than-expected slowdown in UK inflation for November convinced investors to add to their BoE rate cut bets. The sole winner was the Japanese yen.

With no clear catalyst to drive the dollar yesterday, its rebound may have been the result of some short covering ahead of the core PCE data on Friday, and ahead of the Christmas holiday.

Following last week’s dovish Fed decision, investors have penciled in around 150bps worth of rate cuts by the Fed next year, assigning a 90% probability for the first quarter-point decrease to be delivered in March, despite several Fed officials pushing back against the timing and depth of interest rate reductions expected by the market.

Today, the US agenda includes the final GDP for Q3, which is expected to confirm its second estimate of 5.2%, but with the Atlanta and New York Fed models already providing estimates on how the economy performed in Q4, and actually suggesting a slowdown, the market is unlikely to pay attention. The initial jobless claims for last week are forecast to have increased and the Philly Fed manufacturing index for December, although seen improving,  is anticipated to have stayed in negative territory for the fourth straight month.

These data are unlikely to shake market expectations surrounding the Fed’s future course of action, especially with the market eager to find out where the core PCE index, the Fed’s favorite inflation metric, headed in November. The forecast points to a further slowdown to 3.4% y/y from 3.5%, which could convince more participants that the Fed will hit the cut button as soon as March.

Yen stages a comeback, awaits Japan’s CPI prints

Despite the greenback’s rebound, the yen continued recovering some of the ground it lost on Tuesday after the BoJ kept its policy unchanged and refrained from providing hints on when they could take interest rates out of negative territory.

The next test for the Japanese currency may be tonight’s national CPI numbers for November. Both the headline and core Tokyo rates for the month declined, suggesting a slowdown in national inflation as well.

This could somewhat disappoint those who still want the Bank to act as soon as possible, but it is unlikely to halt the yen’s uptrend against its US counterpart, especially with the market anticipating so many rate cuts by the Fed next year. On top of that, the BoJ is paying very close attention to wage growth and another strong pay hike at next year’s spring wage negotiations may be the signal for raising interest rates, perhaps in April.

Wall Street snaps winning streak, gold pulls back

All three of Wall Street’s main indices fell more than 1% each on Wednesday, with the Nasdaq losing the most. The nosedive ended the impressive rally, which has been fueled by expectations of massive rate reductions by the Fed next year. However, calling for a trend reversal with just one down day is unwise and premature.

Equites may have corrected lower due to profit taking or large purchases of put options for hedging purposes as portfolio and fund managers begin their Christmas holidays. Yes, the market seems overstretched and may correct even lower, but should investors remain convinced that the Fed will cut rates massively next year, they could also remain willing to add to their risk exposure again soon.

The rebound in the US dollar and the slide in equites resulted in a pullback in gold. That said, the retreat in gold was smaller than in the stock market, with the precious metal already recovering today. It seems to be struggling to overcome the $2,048 barrier, but with Fed rate cut bets expected to push down the opportunity cost for holding gold, it may be only a matter of time before it jumps higher.