Another Fed Jumbo Hike in Focus as Markets Bet on Policy Moderation

Fundamental outlook for the US dollar: neutral

  • US dollar weakens after S&P 500 gains, Fed worries ease
  • Eyes are on another rise above the 75-basis level on Wednesday
  • After that, Friday’s nonfarm payrolls are likely to cool

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The DXY dollar index fell more than 1 percent in 2 weeks of trading. This was the worst performance in 10 days since mid-July. Several reasons may explain this move. The first is to improve risk appetite. On Friday, the S&P 500 rose nearly 2.4% to close at its highest since late September, dampening demand for safe-haven currencies.

This optimism on Wall Street can be explained by the overall earnings season so far. The second reason for the stumbling of the dollar is a stabilization of the expectations of the Federal Bank ahead of the announcement of the monetary policy in November. Looking at the chart below, the markets have backed off forecasts of a 50-fold rise in 2023, falling just short of a quarter-percentage point move.

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The Fed will almost certainly make another 75-basis rate hike to 4% on Wednesday. But the markets are more interested in what comes next. A 50-basis hike in December, followed by a 25-bps hike in January. In other words, there are growing expectations of federal moderation in financial markets, which is likely to contribute to the rise in the S&P 500 and the decline in the US dollar.

Are markets getting ahead of themselves? The Fed’s top inflation gauge missed September expectations, with core PCE running at 5.1% y/y and 5.2% seen. This is 4.9% more than in August. Meanwhile, the Employment Expenditure Index rose 1.2 percent in the third quarter, up from 1.3 percent previously. Despite the slowdown, it remains at the highest level since 2003.

So the latest data can go either way if you’re trying to figure out if inflation is slowing. However, it is certainly better than if both data beat expectations. Thus, the Greenback’s recent performance looks reasonable. What remains uncertain is how Fed policymakers will approach the rate of tightening in the coming months. Note that the decline in the balance sheet continues rapidly.

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The focus then shifts to Friday’s US non-farm payrolls report. The economy appears to have added 190,000 jobs in October, down from 263,000 in September. The unemployment rate could rise to 3.5% to 3.6% as average hourly earnings slow. Such a cooling in the labor market could reinforce the Fed’s dovish language. This could hurt the US dollar more. Such a possibility keeps the fundamental perspective neutral.

Expect a 2023 Fed rate hike

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The chart is created in TradingView

— Written by Daniel Dubrovsky, Senior Strategist at DailyFX.com

To connect with Daniel, follow him on Twitter:@ddubrovskyFX



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