• David Thatcher

USD: Fed hike plans remain on track amidst heightened tensions in Ukraine


The US dollar has continued to trade at stronger levels during the Asian trading session following the release of the latest NFP report on Friday. The dollar index is now trading around the middle of its recent trading range between the 110.00 and 115.00-levels. US dollar strength has been most evident overnight against the commodity-related G10 currencies of the Australian dollar (-0.7% vs. USD), Norwegian krone (-0.3%), and New Zealand dollar (-0.2%). The US dollar is benefitting both from the rebound in US yields and more risk-off trading conditions. US yields have quickly bounced back after correcting lower at the end of last month /start of this month especially at the shorttend of the curve. The 2-year US Treasury yield is now back within touching distance of the year to date high at 4.35% from 26th September reflecting increased confidence amongst market participants that the Fed will continue to raise rates at a faster pace through the rest of this year. The US rate market has moved to almost fully price in another 75bps rate hike at the next FOMC meeting on 2 nd November followed by a 50bps hike at the final meeting of the year on 14th December. At the same, market participants’ expectations for the Fed’s terminal policy rate next year have been moving back up towards 4.75%.


The hawkish repricing of US rates over the past week has been encouraged by comments from Fed officials pushing back against renewed speculation over a potential dovish policy pivot, while the latest NFP report showed that the US labour market continues to tighten posing upside risks to the Fed’s inflation outlook. The unemployment rate dropped back to the cyclical low of 3.5% in September. The pace of employment growth continued to moderate as the US economy added 263k jobs in September compared to the year to date average of 420k/month, but the softening of labour demand is not sufficient to ease the Feds concerns over the risk of stronger wage growth. The Fed remains optimistic though that labour force participation will pick-up to help ease the tightness in the labour market, but the participation rate dropped back by 0.1 point to 62.3% in September. There was at least some relief that average hourly earnings growth is not accelerating. It was the second consecutive month that average hourly earnings growth expanded by 0.3% which is below the year to date monthly average of 0.4%. Overall, the developments are unlikely to alter the Fed’s tightening plans. The next key test of the Fed’s tightening plans is posed by the release of the latest US CPI for September on Thursday.

At the same time, the US dollar is deriving support from more risk-averse trading conditions at the start of this week which reflects in part the hawkish repricing of Fed rate hike expectations but also some uneasiness over the conflict in Ukraine. The attack over the weekend by Ukraine on the Kerch Bridge linking Crimea to Russia threatens Russia’s ability to resupply forces in the south, and perhaps more importantly is crossing Russia’s self-proclaimed red lines by attacking regions already annexed by Russia. President Putin had ordered the construction of the bridge to help seal the permanent union between Russia and Crimea, and the attack came only one day after President Putin’s 70th birthday. President Putin has described the attack as “as an act of terrorism” and will meet with his Security Council (SCRF) today. The latest developments have increased the risk that tensions will escalate further in the region.


AUD: RBA policy update reinforces downside risks on top of hard landing fears

The commodity currencies of NOK (+1.4% vs. USD) and the CAD (+0.6%)have been the best performing currencies so far this month. The main triggers for the relief rally for commodity currencies include: i) an easing of fears over financial stability risks in the UK after the BoE temporarily stepped in to support the Gilt market, ii) fresh policy measures in China to support the housing market, iii) renewed speculation over a potential dovish Fed policy pivot that has helped ease upward pressure on the USD, and iv) the decision from OPEC+ to cut oil production to support the price of oil (click here). It has already helped to lift the price of Brent back up towards USD100/barrel. The developments have brought some short-term relief for commodity currencies following heavy sell-offs in recent months. Our equally-weighted G10 commodity FX basked has fallen by around 10% against the USD since the high point on 11th August. Over that period the NZD (-13.0% vs. USD), NOK (-11.3%), and AUD (-10.9%) have been hit the hardest while the CAD (-7.1%) has held up better.

Commodity currencies have been undermined in recent months by building fears over a hard landing for the global economy. The ongoing tightening of global financial conditions has been weighing more heavily on commodity currencies. It is evident in the tighter correlations for commodity currencies with global equity market performance and US rates over the past month. USD/CAD (-0.84) and USD/NOK (- 0.83) have had the strongest correlations with MSCI’s ACWI global equity index. For most of this year, USD/JPY has had the strongest correlations to US rates but that has changed over the past month as policymakers in Japan have pushed back more forcefully against further JPY weakness. Over the past month the commodity currencies have had the strongest correlations to US rates. The negative impact of global slowdown fears has also been more evident on raw industrial commodity prices. The CRB RIND index has fallen by almost 8% since mid-August, and extended the sell off from the April peak to almost 18% as it moves closer to bear market territory.

Over the past week, the AUD has underperformed other commodity currencies driven by a shift in monetary policy expectations. The RBA’s surprise decision to slow the pace of tightening by delivering a smaller 25bps hike this week has weighed on the performance of the AUD. In contrast, other G10 central banks including the Fed, BoC and RBNZ have continued to deliver hawkish policy signals to market participants. The RBNZ delivered a fifth consecutive 50bps hike and hinted that the terminal policy rate is likely to be raised above 4.1% while BoC Governor Macklem reiterated that there is “more to be done” to curb inflation pressures reinforcing market expectations for a 50bps hike at their next policy meeting on 26th October. In these circumstances, we continue to believe that risks remain tilted to the downside for commodity currencies in the near-term. The RBA’s policy shift has increased the likelihood that AUD/USD will fall towards the 0.6000-level, and we recommended adding short positions to the AUD/USD currency.

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