Weekly Market Update 2 December – Dollar edged lower after dovish FOMC statements and softer inflation data

Weekly Market Update 2 December – Dollar edged lower after dovish FOMC statements and softer inflation data

1. Dollar edged lower to around 104.5 by the week’s end after dovish Fed statements corresponded with softer than expected labour market and inflation data. Although non-farm employment increased by 127k, this was lower than market expectations of 196k and the lowest level since February this year. The number of JOLTS job openings continued to fall to 10.33 million from a peak of 11.55 million in May. While the vacancies are still significantly higher than pre-pandemic levels of around 7 million, the noticeable declining trend indicates that the tight labour market is beginning to loosen. Further labour market loosening in the months to come could provide confirmation that demand driven inflation in the US is coming under control, lowering the impetus for Fed rate hikes which could weigh down the Dollar even more. Beyond the labour market, the effect of previous aggressive Fed rate hikes can also been seen directly on inflation itself. Core PCE Price Index came in at 0.2% this month which was lower than market expectations of 0.3%, representing the second consecutive month in a row of decline since September. In response to these early signals of a cooling economy, Fed Chairman Jerome Powell said on Wednesday that “the time for moderating the pace of rate increases may come as soon as the December meeting”. Although markets already expected the pace of rate hikes to slow in 2023, by how much and how early this will occur is still up for speculation. A rapid decline in the Dollar could be seen on Thursday after investors dumped the currency in anticipation of a weaker rate hike due at the upcoming FOMC meeting on 15 December. As the Fed attempts to balance its dual mandate of stable inflation with economic growth, it closely monitors indicators of future economic performance to factor into the lagging effect of current monetary policy. At present, America’s economy still appears robust. The increase in average monthly earnings were double market expectations at 0.6%, in line with abnormally higher wage growth since the pandemic. Quarterly preliminary GDP recorded a modest but healthy growth of 2.9%. Recent data on the unemployment rate came in at 3.7%, which was perfectly in line with market expectations and data from previous months since it stabilised around a healthy range of 3.5%-3.7% after spiking during the Covid pandemic. However, ISM Manufacturing PMI which is an indicator of the future economy performed poorly after it extended its steady decline since the start of the year into contractionary territory of 49.0, which was worse than expectations of 49.7. This represents the worst PMI results and the first time it has dipped below 50 since the height of the Covid pandemic in 2020. If economic performance eventually plays out according to what the PMI data suggests, and if labour and inflation data continue to be soft in the coming months, then the Fed will have even more reason to moderate its interest rate policy which could see the bearish Dollar extend well into 2023.

2. Euro extended its rally to close the week at around 1.053, reaching its highest level since June this year since its bullish reversal in October. After seeming to stall in a ranging trend last week and even temporarily decline on Monday morning, ECB president Christine Lagarde hit the pedal on the currency following Hawkish statements at a meeting in the European Parliament. President Lagarde reiterated the ECB’s commitment to attaining 2% inflation and the unrelenting need for further rate hikes until that goal is achieved. Investors are keenly anticipating the last ECB meeting of the year on December 15 December where ECB members are set to decide between a third straight 75 bps hike or a moderated 50 bps hike. Crucially, the ECB meeting is set to take place just hours after the FOMC meeting on the same day. Investors will be closely comparing the interest rate differential between the two Central Banks which will determine how the Euro performs against the Dollar in the new year. Given the ECB’s consistently hawkish orientation contrasted with the Fed’s recent dovish statements, we could see the gap in interest rates narrow. However, Flash Core CPI data for November increased at the same rate as the previous month of 5% after continuous month on month growth since July. Flash CPI estimate actually decreased from the previous month at 10%, which was also lower than market expectations of 10.4%. Europe’s largest economy; Germany, also recorded its first CPI contraction of -0.5% for the first time since last year. While the recent data may seem to hint at tentative signs of softer inflation to come, President Lagarde dismissed those ideas and claimed that Eurozone inflation had not peaked, and in fact risks turning out even higher than expected which could extend the Euro’s ascent. Similarly, the Pound pared recent losses after dipping on Wednesday, to end the week higher at around 1.22 against the Dollar. The Pound has largely been buoyed by a bearish Greenback which saw a steep decline this week after dovish FOMC statements.

3. Commodity currencies rallied across the week as hopes of China’s re-opening spurred optimism in the market despite a bullish Dollar. Kiwi, Aussie and Loonie edged higher by the week’s end to 0.64, 0.68 and 0.74 respectively. A week of intense protests across China has seen unprecedented public displays of criticism towards President Xi Jin Ping for his government’s strict zero-covid policy which has stifled economic growth since 2019. Speculations that the regime would give in to mounting pressure from protest demands were reinvigorated on Wednesday when an easing of Covid restrictions was announced in Guangzhou and Chongqing. Top Covid-19 official Vice-Premier Sun Chunlan subsequently announced that China’s policy on handling the pandemic was entering a new phase, representing the first official recognition of a potential change in stance. Since the beginning of the month, Goldman Sachs had already forecasted China’s re-opening by the 2nd quarter of 2023 or earlier, which it reiterated again in a statement on Wednesday. Asian-Pacific markets immediately jumped on the prospect and risk appetites ballooned, which was reflected in across-the-board gains made by major indexes in the region such as the Nikkei 225, Hang Seng and Australia ASX. Rather than a result of fluctuations in the Dollar which has in fact largely remained bullish till Wednesday, the ascent of risk-sensitive commodity currencies was directly driven by a decisive shift to a risk-on sentiment as recent revelations from China sent ripples throughout the market. Recent economic data for the 3 economies also show relatively stable consistency with previous months. As Australia and New Zealand’s largest trading partner, and Canada’s second largest, the beggar-thy-neighbour effect of China’s strict Covid rules had previously weighed down the export dependent commodity currencies. Investors should closely monitor more signs of re-opening to come which could add further bullish fuel.

4. Following a similar trend to the commodity currencies, the price of Brent Crude rallied throughout the week to close at around $85.9 riding a wave of speculation that the potential easing of Covid restrictions in China could reignite demand in the world’s largest market for the fossil fuel. Price spiked on Thursday following a dip in the Greenback on the same day which boosted the Dollar denominated commodity on the back of cheaper foreign currency conversion rates. Similarly, Gold extended its rally to over $1797 per ounce by the week’s end on the back of the bearish Greenback. US Treasury Yields across all maturities also declined across the week upon news of slower Fed rate hikes, leading investors to shift their sights from the fixed income security to Gold as the opportunity cost of holding the non-yielding asset fell.