Evening Brief – 09.08.23
Keep Your Eye on the Buck
The major story of the week(s) has been the incredible moves in global currencies, particularly the US dollar, and the growing disparity in economic growth expectations between the US and the rest of the world.
The ICE US Dollar Index (DXY), which measures the strength of the US currency against a basket of six G-10 currencies, rallied for the eighth week in a row this week. The current streak is the longest run since 2005. The DXY reached a high of 105.15 on Thursday, levels not seen since March.
“The dollar upside we have seen recently has surprised our expectations,” Laura Cooper, senior investment strategist at BlackRock International, said in an interview on Bloomberg Television. “We question the sustainability of that, largely as we look forward to the Fed, we think it is going to signal a hawkish pause.”
Over the last two months, the US dollar has risen significantly against all major currencies, most notably the Chinese yuan.
China’s central bank has aggressively weakened the yuan to counteract the country’s deflationary economic environment, and it could certainly benefit from some reflationary policy, such as a weaker yuan.
At the same time, Federal Reserve officials discussed this week whether monetary policy needs to be more restrictive or if enough has been done, which impacts the currency’s movements.
Officials must fine-tune monetary policy to ensure inflation continues to trend down toward its 2% target. However, with WTI crude oil prices approaching $90, upward inflation pressure is anticipated. This is expected to further propel the dollar’s recent surge.
Dallas Fed president Lorie Logan said it could be appropriate to skip an interest rate increase in September but “skipping does not imply stopping” rate hikes, while she noted that “there is work left to do” to get to sufficiently restrictive policy and is not yet convinced they have extinguished excess inflation.
According to New York Fed President John Williams, the Fed is “in a good place” and “we are restrictive, but it is still an open question whether we are sufficiently restrictive.” Atlanta Fed President Raphael Bostic underlined the restrictive policy tone, saying, “we just need to let that restriction play out.”
The dollar has been bolstered by a strong macroeconomic picture, as opposed to rallying during periods of risk aversion, and this week’s favorable economic news has further added to the dollar’s bullish outlook.
Weekly US unemployment claims fell to their lowest level since February, at 216k, compared to expectations of 233k. A strong ISM services report on Wednesday added to the perception that the US economy is in better shape than previously thought.
The data has led markets to increase the prospects of another hike from the FOMC this year. According to the CME Fedwatch Tool, the probability of a hike at the next meeting on September 20 is 5%, while the odds of a November 1 hike is 43%, up from 33% one week ago.