Can the US Dollar Continue Its Correction?
Bonds underwent another tumultuous day in the trading arena, but this time, there was a notable drop in yields. This change was partially influenced by a lacklustre ADP payroll report, which is infamous for its unreliable predictive abilities. The report acted as a deterrent against further selloffs.
Nevertheless, it’s crucial to emphasize that the temporary relief observed in the bond market and the corrective shift in the value of the dollar may be significantly reliant on the expectation of disappointing employment data. In different financial sectors, the Riksbank may have subtly indicated its forthcoming involvement in the realm of foreign exchange hedging.
The recent session saw a pause in the US bond markets, with 10-year yields dipping below the 4.75% threshold after an earlier climb to 4.88%. This halt in the bond sell-off was partially influenced by a slowdown in private ADP payrolls, which dropped from 180k to 89k in September, well below the expected 150k consensus estimate. It’s noteworthy that the market’s response to ADP figures continues to perplex, as they have little predictive power for actual payrolls. Interestingly, ING economists have observed an unusual inverse correlation: weak ADP figures often lead to strong official payrolls.
The ISM services index showed a slight deceleration in various survey measures, although they all remained comfortably above the growth threshold of 50. Notably, there’s a contrast with the S&P PMI, which covers the same group of companies but reported stagnant activity at 50.1, as opposed to the more optimistic reading of 53.2 by the ISM.
In the foreign exchange market, attempts to correct the dollar’s course have been ineffective. The recent change in interest rate differentials due to the bond sell-off has made selling the dollar a challenging task, and cautious trading ahead of the upcoming US payroll data release is exacerbating the situation.
Market pricing continues to lag the FOMC dot plot expectations, with rates projected to be 15 basis points lower by the end of 2023 and a more substantial 50 basis points lower by the close of 2023. Although the 2-year USD swap rate corrected by 10 basis points recently, falling below the 5.0% mark, it appears to hinge excessively on the assumption of weak job figures, despite the unreliability of ADP as a predictor. Consequently, there’s room for a more bullish repricing at the beginning of the USD yield curve, and the dollar still faces considerable upward potential.
The DXY may find stability around the 106.00 mark today as the market evaluates whether jobless claims can maintain their trend of surprising on the downside (which is negative for bonds and positive for the dollar). Additionally, several Federal Reserve speakers, most of whom are hawks, are scheduled to speak, likely lending further support to the possibility of another rate hike.
Regarding US politics, the removal of House Speaker Kevin McCarthy seems to have had minimal impact on FX markets. However, risk assets like equities may experience turbulence if potential successors struggle to garner sufficient support, resulting in a protracted process. In such a scenario, safe-haven currencies like the yen or the Swiss franc may gain favour as concerns about US political instability could overshadow the dollar’s traditional safe-haven status, especially if coupled with economic growth risks and a consequent dovish reassessment of Fed expectations.
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