The hawkish narrative that the Federal Reserve delivered in its latest press conference has been well covered. Jay Powell’s divergence from how the market perceived the peak of US interest rates has provided an element of support to the US Dollar. We can say with conviction that at least in the hours and days following the decision and press conference last week that much price movement was being driven by this USD positive story forcing most Dollar-termed crosses lower including noticeably GBPUSD and EURUSD. However, both of these pairs find themselves on firmer and higher ground this week with a sharp yet sustained correction at market open yesterday restoring both of these crosses to pre-FOMC levels. Whilst the base currencies GBP and EUR have played their own parts in this correction, this more widespread theme has been of USD drawback.
There are three main factors behind this reversal. Firstly, there is still an element of data vulnerability behind the US Dollar. As well as Fed speakers pencilled in for tomorrow markets will be focussing on the inflation reading that is due to be published on Thursday. On Friday, the Michigan Consumer Sentiment preliminary reading will also be published. This fast moving so-called ‘soft data’ has afforded itself an increased significance and market impact given the highly uncertain environment we are seeing economically worldwide. Investors are therefore wary of holding too much USD ahead of these data releases knowing the potential damage and volatility that these releases could bring to the greenback.
The second and also highly influential factor for USD crosses has to be China. China’s zero-Covid policy has been in focus once again with the world speculating over cryptic clues as to how the nation’s health policy will evolve. The suggestion that China may drop some restrictive elements of its health policy have provided the global economy with a degree of optimism. That has forced a partial liquidation of the net long positioning that markets have held onto for some time that has served as a safehaven from global risk. There has been some push-back from Chinese officials over speculation that China will end its zero-covid policy altogether limiting the extent to which this risk-on rally may dent USD.
Lastly but certainly not least of all is the US midterms. There is an argument to suggest that in an environment where everyone is focussed upon economic and monetary factors with respect to most of the fixed income and currency markets, that mid-term political elections will not have a great influence on conditions and therefore valuations. However, this is only true to the extent to which the mid-terms do not impact the economic and monetary infrastructure that underly the economy. There is a particular high-risk outcome of these mid-terms which involves President Biden losing control of Congress. If the result of these mid-term elections now underway were to tie the hands of fiscal progress in the United States, then the US could suffer economically from any downturn in the months and years ahead. Economic growth is a hugely important variable in currency valuations and if the result of these mid-term elections changes the ease of fiscal decision making sufficiently then the US could be on the backfoot as inflation and growth recede.
Discussion and Analysis by Charles Porter
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