The US dollar has fallen to new lows on the day pretty much across the board (not yet against GBP).
The market is continuing to digest the Powell comments and it’s the front end of the yield curve where the strongest buying remains. US 2s are down 9 bps to 3.92% and near the lows of the day as the longer end has come off the extremes.
Much of the talk in the market is about 25 vs 50 bps or where Fed funds will be at the end of the year but what matters is the terminal rate. Fed officials have been talking about 3% this week or something else around ‘neutral’ but doing “everything we can” to support the labor market doesn’t mean stopping at 3% (if necessary).
David Rosenberg also picked up on something from Powell and wrote:
Powell let the cat out of the bag when he said that the jobs market is looser now than it was in 2019. What we know about 2019 was that the Fed was cutting and went all the way down to 1.75%. So, let’s just say that it’s nice to know the destination point, which the Treasury market, as strong as it has been, has yet to fully reflect.
Now I don’t really think there is a signal from Powell about going below 3%, and that decision isn’t coming for awhile but if we’re at the point where the inflation debate is over (I think it is for now), then we need to re-visit the idea about where the bottom of Fed funds is.
That’s what I think this dollar selloff is getting at. A month ago, there was a good argument that other central banks would be cutting more than the Fed simply because growth is weaker elsewhere. The sentiment about growth is true but now we’re finding out that the Fed might not care and could be determined to keep unemployment here and growth well-above 2%.
Now you could argue that’s stoking inflation but maybe not and what was assumed about US rates being materially higher — than say AUD — isn’t a given. With that, we now have AUD/USD at the highs of the day and threatening the July high.
AUDUSD daily
Now I’m not fully on board with this thinking as I think it’s way too early to price in 1.75% Fed funds. There’s also the thorny question about the election, fiscal policy and who will be Fed chair after Powell.
So the question is: How crowded is the USD trade and how much money is waiting to exit and pile into pro-cyclical trades like emerging markets? That’s a tough one to answer but it’s probably the way the wind will blow until/unless we start to see some really weak economic data and global growth.
