Fed’s cautious approach underpins dollar strength
The recent release of the September Federal Open Market Committee (FOMC) minutes has revealed a Federal Reserve (Fed) that, while acknowledging the need for monetary policy recalibration, is in no rush to aggressively cut interest rates. This cautious stance has provided support for the US dollar, as investors recalibrate their expectations for future rate cuts.
Despite delivering a substantial 50 basis point cut in September, the minutes showed a lack of unanimity among FOMC members. Some favoured a more modest 25bp reduction, indicating that future cuts will likely be subject to robust debate within the committee. This revelation has prompted markets to reassess their expectations, with the Fed’s terminal rate for this easing cycle being repriced 50bp higher over recent weeks.
Market reaction and widening yield differentials
The immediate market reaction to the minutes was relatively muted, with short-dated US yields ticking up only slightly. However, the broader trend over the past few weeks has seen a significant movement in the dollar’s favour. The EUR/USD two-year swap differentials have widened from 85bp to 130bp in about three weeks, explaining the recent pressure on the EUR/USD pair, which has drifted towards the 1.09 level.
Upcoming factors that could influence dollar trajectory
CPI data release: A potential game-changer
All eyes are now on the impending release of September’s Consumer Price Index (CPI) data. A core CPI reading of 0.3% month-on-month (MoM), slightly above consensus, could further bolster the dollar’s position. Such a result, while not derailing expectations of a 25bp cut from the Fed in November, might limit the central bank’s room for more aggressive easing.
Fed speakers on the horizon
Market participants will also be keenly listening to upcoming speeches from Fed officials Tom Barkin and John Williams, both considered modest hawks. Their comments could provide additional insight into the Fed’s thinking and potentially influence dollar sentiment.
Global context: balancing acts and uncertainties
Chinese stimulus and commodity currencies
The forex market remains choppy, influenced by stimulus measures from China and ongoing instability in the Middle East. Anticipation of significant new bond issuance by the Chinese Ministry of Finance is providing some support to commodity currencies, creating a counterbalance to dollar strength.
US election looms large
With the US presidential election now less than a month away and polls suggesting a tight race, uncertainty is creeping into the markets. This environment of political ambiguity typically favours the dollar, as investors seek safe-haven assets.
EUR/USD outlook – technical analysis
The pair continues to decline ahead of next week’s European Central Bank (ECB) meeting. A brief bounce earlier in the week was met by a wave of selling following the Fed minutes, which took the price to its lowest level since mid-August.
While the EUR/USD uptrend is still in place, the pressure appears to be building as the fundamental gap between the ECB and Fed widens. The former is now on course to cut rates next week, and that has continued to put downward pressure on the pair. While a 25bps cut by the Fed is still viewed as highly likely, the chances of a hold are creeping up, boosting the US dollar.
A recovery back above $1.0950 might help to establish a higher low and save the uptrend for the time being. However, the steep losses from $1.12 in mid-September means that there is a lot of work to be done to help restore a bullish view.
Further declines would target the August lows down towards $1.08.
