USD Selling Not Sustained for Long!

The US dollar experienced an unexpected and notably significant sell-off on Monday but rebounded strongly yesterday, effectively recovering all the losses from the previous day. While there were initial concerns that this might signify the beginning of a decline in US exceptionalism, it was premature to conclude that the US dollar was about to experience sustained depreciation. Market positioning could have led to further selling, but the official data released yesterday provided strong support for the dollar, ultimately enticing USD bulls to buy at levels that had seemed unattainable just 24 hours earlier.

The catalyst for selling the Euro (EUR) was the initial release of Purchasing Managers' Index (PMI) data in Europe. All three PMI readings for the Eurozone came in weaker than expected, signalling the potential for mild recessionary conditions. However, in my opinion, this doesn't necessarily guarantee a decline in EUR/USD. A backdrop of a recession doesn't necessarily mean that EUR/USD is heading lower. A level of 1.0500 for EUR/USD largely reflects the current divergence between the Eurozone and the United States.

In contrast, PMI data from the United States painted a different picture. All three PMIs in the US exceeded expectations, showcasing a strong economic performance. The response in the rates market was somewhat muted. While the 2-year US Treasury (UST) bond yield increased by about 5-6 basis points, the 10-year UST bond yield barely moved, retaining the drop from its peak on Monday at 5.02%.

In the foreign exchange market, however, there was a swift reversal of the Monday sell-off and more. As I’ve emphasized in my previous FX Daily report, even with the drop in EUR/USD, around the 1.0600 level, there is still a case to be made for the Euro's resilience. This is evident when considering the market events over the past month, such as the rise in US yields, growing concerns related to Italy, and increased natural gas prices following the Hamas attack on Israel. This resilience is underscored by the chart illustrating EUR/USD against the performance of the Euro versus other G10 currencies, excluding the US dollar. The EUR vs G10 ex-USD index reached a year-to-date high yesterday.

I’ve mentioned that there was a window of opportunity for further US dollar strength, but I expected this window to close before the end of the year, resulting in a retracement. This forecast was based on the anticipation of weaker economic data from the US. Tonight, strong data for Q3 GDP, with a consensus of 4.5% Q/Q SAAR, will be released, capturing the robust data recorded during the summer, which saw US yields rise and EUR/USD drop from 1.1200. The current consensus for Q4 Q/Q SAAR growth is just 0.7%.

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