The recently released minutes of the September Federal Open Market Committee (FOMC) meeting showed that the Federal Reserve (Fed), while acknowledging the need to recalibrate monetary policy, was in no rush to cut interest rates significantly. This cautious stance provided support to the US dollar as investors recalibrated their expectations for future rate cuts.
Despite the sharp 50 basis point rate cut in September, the minutes showed a lack of unanimity among FOMC members. Some preferred a more modest 25 basis point rate cut, suggesting that future rate cuts may be influenced by intense debate within the committee. The news prompted the market to reassess its expectations, and in recent weeks, the Fed has repriced the final rate for this round of easing cycle by 50 basis points.
Market reaction and spread widening
The immediate market reaction to the minutes was relatively mild, with short-term US Treasury yields rising only slightly. However, the overall trend over the past few weeks has seen a significant change in favor of the US dollar. The EUR/USD two-year swap spread has widened from 85 basis points to 130 basis points in about three weeks, which explains the recent pressure on EUR/USD, which has floated towards the 1.09 level.
Factors that could affect the dollar in the future
CPI data release: potential game changer
All eyes are now on the upcoming September Consumer Price Index (CPI) data. The core CPI rose 0.3% month-on-month, slightly above market expectations, which could further support the dollar's position. While such an outcome would not affect the Fed's expectations of a 25 basis point rate cut in November, it could limit the central bank's room for more aggressive easing.
Fed speakers coming soon
Market participants will also be closely watching upcoming speeches by Fed officials Tom Barkin and John Williams, both of whom are considered mildly hawkish. Their comments could provide further insight into the Fed's thinking and could affect dollar sentiment.
Global context: balancing act and uncertainty
Chinese stimulus and commodity currencies
Foreign exchange markets remain volatile, affected by China's economic stimulus measures and continued instability in the Middle East. Expectations that China's Ministry of Finance will issue a large amount of new bonds have provided some support for commodity currencies, forming a counterweight to the strengthening of the US dollar.
US Election Looming
With less than a month to go until the US presidential election, and polls showing a close race between the two parties, uncertainty is creeping into the market. This politically ambiguous environment is generally favorable for the US dollar as investors seek safe-haven assets.
The pair continues to fall ahead of the European Central Bank (ECB) meeting next week. The euro briefly rebounded against the dollar earlier this week, but a wave of selling after the release of the Federal Reserve minutes has taken the euro to its lowest level since mid-August.
While the EUR/USD uptrend remains in place, pressure appears to be building as the fundamental gap between the ECB and the Fed widens. Currently, the ECB will cut interest rates next week, which will continue to put downward pressure on the currency pair. Although the probability of a 25 basis point rate cut by the Fed remains high, the probability of no action is rising, which boosts the US dollar.
A recovery above 1.0950 could help establish a higher low and preserve the uptrend for the time being. However, the euro's sharp decline from 1.12 in mid-September means there is still a lot of work to do to restore the bullish view.
A further decline would target the August low to 1.08.
Market expectations and US dollar index targets
Current market pricing suggests around 40 basis points of rate cuts over the remainder of the year, which is very close to the Fed's expectation of a full rate cut of around 100 basis points by the end of the year. This pricing equilibrium is likely to limit further appreciation of the dollar in the near term.
However, if the US core CPI surprises to the upside, we may see bids in the US dollar index (DXY) in the 103.35 area. Continued geopolitical uncertainty may provide additional support for the dollar.
Conclusion: The shine of the dollar may continue
In summary, a cautious Fed, resilient US economic data and global uncertainty together paint a picture of continued strength in the US dollar in the near term. While some consolidation may occur if market prices stabilize around current levels, the overall outlook for the dollar remains favorable. Investors and traders alike need to remain vigilant to upcoming economic data and Fed messages, which have the potential to change the situation quickly.
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Indonesia
2024-10-11
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