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- USD limps into the weekend amid blight of bad data.
- Market has now gone all-in on an October rate cut.
- Analyst forecasts of further cuts are also stacking up.
- Factory sector in trouble and spillover risks are rising.
- Commitment to easing cycle needed to end USD trend.
The Dollar was limping toward the weekend Friday as financial markets appeared to go all-in with their bets on another Federal Reserve (Fed) being delivered this month, although some analysts say a clear commitment to a protracted easing cycle is necessary to decisively end the greenback's uptrend.
American factories are struggling badly after a year and a half of U.S. trade war with China and economists are increasingly concerned that a downturn in the manufacturing industry could soon spillover into the rest of the economy, leading to slower growth and undermining the outlook for inflation. And markets are betting this is all that's necessary for policymakers to cut the Fed Funds rate to 1.75% on October 30, which would be the third 2019 reduction of interest rates.
U.S. industrial production fell by 0.4% in September when markets had looked for only a 0.1% decline, while the Philadelphia Federal Reserve manufacturing index also fell sharply and housing starts underwhelmed for the month of September, official figures showed on Thursday. Those numbers came hard on the heels of Wednesday's retail sales report, which revealed a surprise fall in store spending last month, all of which have helped undermine the greenback.
Pricing in the overnight-index-swap market has gone from implying an October 30 Fed Funds rate midpoint of 1.66% to one of 1.63%, with the total implied change rising to -24 basis points, this week. That suggests investors now think the Fed is almost certain to announce a 25 basis point cut at the end of this month, which is a significant deterioration of the general expectation on September 18, the day of the previous decision, when pricing implied that investors saw little chance of a move in October.
Above: Dollar Index shown at daily intervals.
"Soft US manufacturing output yesterday further increased the case for a Fed rate cut this month," says Petr Krpata, chief FX strategist for the EMEA regions at ING. "While clearly not positive for USD, to the extent to which the Fed follows the same script of past months (a reactive, rather than pro-active, approach to the deteriorating US data with a limited pre-commitment for a meaningful easing cycle) this should have a limited negative effect on USD."
Krpata and the ING team forecast further cuts in December and January too but say those moves won't do much damage to the Dollar unless Federal Reserve Chairman Jerome Powell pre-commits to a protracted cycle of cuts. They say that, without such a commitment, investors' expectations for global growth are unlikely to be materially improved and it's a stronger global economy that's really necessary to weaken the Dollar because without one there will be little else investors can buy other than the greenback. The Fed will announce its next rate decision at 19:00 on Wednesday, 30 October.
Vice Chair Richard Clarida did little to discourage the notion the Fed will cut rates at the end of this month when he addressed a Chartered Financial Analyst (CFA) Institute on Friday. Clarida emphasised that "muted inflation pressures", weak global growth and signs of a slowdown in the domestic economy were behind the July and September decisions to cut rates, before saying the Federal Open Market Committee will continue to make decisions on a meeting-by-meeting basis. The Dollar sold off afterward.
The Fed's rate is the highest among so-called G10 countries, which has made U.S. government bonds and other assets more attractive to investors, especially in light of the dire rate picture in other parts of the world like the Eurozone. Rates are low and falling elsewhere because of the weak global economy, which has weakened in response to the trade war with China as well as the international effect of the nine earlier Fed hikes seen since the end of 2015.
Above: Pound-to-Dollar rate shown at 4-hour intervals alongside EUR/USD (orange line, left axis).
"The critical support factor for a proper turn lower in the US dollar is assurance that the Powell Fed will continue to provide easing at every turn and at least stay on top of the curve if not get ahead of it in providing further easing in the form of rate cuts and balance sheet expansion," says John Hardy, chief FX strategist at Saxo Bank. "Next key for cementing this USD move lower is the FOMC."
Geopolitical developments are also putting a dampener on the safe-haven Dollar, in addition to the Fed outlook, with a Brexit deal between the UK and EU said to have been reached Thursday at the same time as the U.S. backed away from an economic as well as diplomatic confrontation with Turkey over its military incursion into Syria. Both those events followed last Friday's accord between the U.S. and China, which has already averted one tariff increase and reduced risks to the global economy.
However, there's a chance that some of those tailwinds could turn to headwinds next week, most notably the boost coming from the Brexit deal. There is a high chance that Prime Minister Boris Johnson will fail to get his new withdrawal treaty through the House of Commons on Saturday, possibly leading to some of this week's gains for the Pound and Euro to be unwound on Monday, while offering support to safe-haven currencies. And some still doubt the recent U.S.-China accord can last for very long.
"A commitment on stimulus packages seems unlikely this year. This is one of the reasons why we maintain our 1.09 forecast for the end of this year. The other reason is that the market, in our view, reacted too positively to the October trade talks between the US and China. The threat of another tariff round remains and volatility is likely to return before the year ends," says Thomas Flury, a strategist at UBS, referring to the Euro. "USD weakness is probably also related to the rising challenges that the Trump administration faces ahead of elections. Their policy has helped to strengthen the greenback in 2018 and 2019. With the pressure on Trump rising, it seems logical that the USD weakens."
Above: Commerzbank chart showing Dollar Index with technical indicators overlayed. Dated Tuesday.
Karen Jones, head of technical analysis at Commerzbank, had warned earlier this week that the Dollar index was increasingly "vulnerable to the downside" after testing for a second time a key trendline located around 98.31 on the charts. She tipped a move down to the 97.55 levle, which has since played out largely because of gains by Pound Sterling and the Euro.
The Dollar index is a broad measure of the greenback relative to a number of its most frequently traded rivals although the Euro-to-Dollar rate has a more than 50% weighting in the benchmark, which means the single currency has a significant influence over the trajectory of the so-called broad Dollar. And Europe's unified unit is still being boosted by relief over the prospect of a 'no deal' Brexit being averted at the end of this month.
However, the rub for the greenback is that both Sterling and the Euro are being tipped to advance even further over the coming weeks. Jones, who draws her insights from studies of trends and momentum on the charts rather than developments in the UK parliament and global economy, is looking for the Euro to reclaim its 200-day moving-average located around 1.1211 and says the Pound-to-Dollar rate could soon rise all the way to 1.3156.
Those forecasts would be enough to put the Dollar index under fresh downward pressure although there's uncertainty over the exact timing of any such move because Jones' prediction relate to the next one-to-three weeks.
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