The Dollar may Stabilize Ahead of the FOMC

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Marc Chandler
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Verbal intervention proved sufficient to keep the US dollar below JPY145, but the greenback gained broadly. It rose to new two-year highs against the dollar-bloc and Chinese yuan ahead of the weekend and to levels against sterling not seen since 1985. The elevated price pressures, while the labor market stays tight (weekly jobless claims fell for the fifth consecutive week and reached four-month lows), have encouraged the market to look for a higher terminal Fed funds rate. At the end of August, the peak in the policy rate was seen 3.75%-4.00%. Now is it seen closer to 4.50%.

We expected the dollar to trade higher into the conclusion of the FOMC meeting on September 21, but last week's gains were particularly strong against those currencies, like the dollar bloc and the Norwegian krone, that are associated with risk and levered to world growth. They were off 1.75%-2.65%. The euro, yen, and Swiss franc were off least among the majors, shedding about 0.33%. 

Only the Russian rouble and Peruvian sol in the emerging market space gained against the dollar. The JP Morgan Emerging Market Currency Index fell 1.0%, its third consecutive weekly decline. It is off a modest 5.7% this year. The Dollar Index, which measures the US dollar against a weighted basket of major currencies, is up about 15% this year. The Bannockburn World Currency Index, a GDP-weighted index of the top 12 economies (half of which are emerging markets), is off by about5.25%. Contrary to the general impression, this review of the relative performances shows that the major currencies have generally fallen more than EM currencies, with, of course, notable exceptions.  

The eroding economic outlook, while the effort to tighten financial conditions will continue into next year, warns of the scarcity of risk appetites. US equity indices could retest the June lows, and so can Europe's Stoxx 600. Earlier this month, the MSCI Asia Pacific Index fell to new two-year lows. The trajectory of weaker growth impulses and tighter financial conditions weigh sentiment, and it is difficult to see what can turn it around soon. The Federal Reserve's new projections can be expected to ratify the market's judgment that the likely terminal rate has increased from what it thought (median dot) in June. The Bank of England is expected to deliver another 50 bp hike. While complaining about the yen's volatility, the BOJ is likely to insist that its monetary setting is appropriate, underscoring the significant divergence of policy.  

Dollar Index:  The Dollar Index fell to 2.5-week lows before the August CPI was reported.   It shot up and closed at a three-day high, recording a bullish outside up day. After consolidating in narrow ranges for the subsequent two sessions, it recorded the high for the week ahead of the weekend, slightly above 110.25. There is little to prevent a move to the 20-year high set on September 7 near 110.80. The momentum indicators are turning higher from the middle of their ranges. The next target may be around 111.30, but in the big picture, the risk may extend toward 117.50-120.00.  Still overall, we are inclined to see some near-term consolidation and this could see the Dollar Index slip back into the 108.60-80 range. 

Euro:  The euro was turned back from almost $1.02 at the start of the week, and the US CPI drove it below $1.00. It was unable to close above there since. However, the selling pressure on the euro has been relatively modest compared with most other major currencies. With the 0.75% loss last week, it has hardly changed since the US jobs report on September 2 (when it settled around $0.9955). The MACD looks poised to turn lower, while the Slow Stochastic already has. Still, there is scope for corrective pressures that could lift the euro back toward $1.0070-$1.0100. The euro's 20-year low, set on September 6, was by $0.9865 and is obviously what the euro bears want to see next. 

Japanese Yen:  Japan's threat to intervene in the foreign exchange market does not seem particularly credible. Within hours of officials upping the ante, the BOJ announced an increase in its regular purchases of Japanese government bonds. This is to say that while the market was contemplating the risk that the Fed would hike by 100 bp, the BOJ increased the pace of its balance sheet expansion, albeit marginally. Three conditions seem to boost the chances of successful intervention:  if it is a surprise, multilateral, and signals a policy change. None of these conditions are met. We understand that the BOJ is in frequent contact with banks in Tokyo. That the media reported that the BOJ checked prices is a feint. Still,  the jawboning managed to keep the greenback rangebound last week between about JPY141.50 and JPY145.00. It mostly traded JPY142.80-JPY143.80 in the last two sessions. The momentum indicators are stretched, and continued sideways movement in the exchange rate can send them lower. A break of JPY141.50 could spur a more significant correction. The key is US rates, and here there may be some relief if the two-year yield steadies around 4% and the 10-year near 3.50%.  

British Pound: Sterling posted a big outside down day on the back of the US CPI and took another leg down ahead of the weekend in response to an abysmal retail sales report. It was pounded to $1.1350, a level not seen since 1985. It seems a striking way to commemorate the 30th anniversary of Black Wednesday and the dramatic exit from the European Exchange Rate Mechanism. Sterling's decline also coincided with the market downgrading the likelihood of a 75 bp hike next week. The swaps market wagers on a 75bp hike peaked at about 82% on September 5 and were still near 70% as recently as September 14. However, it fell around 15% before the weekend. The momentum indicators have not confirmed sterling's new lows. However, it might suggest the possibility of a steadier tone, perhaps have of the BOE meeting. The $1.1450 offers the initial cap, but corrective forces could spur a test on the $1.1500-50 area, which previously provided support.  

Canadian Dollar:  The steep sell-off in US stocks proved too much for the Canadian dollar, which fell to new two-year lows ahead of the weekend. The US dollar had been absorbing offers around CAD1.32 but could not close above it until September 15. Follow-through buying lifted it slightly above CAD1.33 ahead of the weekend. The CAD1.3340 area is the (50%) retracement of the greenback's downtrend from the panic high in March 2002 (~CAD1.4670). The next important chart area above there is CAD1.3400-20. The momentum indicators have scope for more gains. The cautionary note comes from the upper Bollinger Band that will start the new week near CAD1.3275. The CAD1.3200-20 will likely offer support, and then CAD1.3150. Next week, Canada will likely report that headline CPI slowed in August, but the core measures didn't. Canada may also report the biggest drop in retail sales (July) since April 2021 and the first decline this year. This will add to the growing indications of slowing economic activity.  

Australian Dollar:  Outside down days on Tuesday and Thursday last week set the stage for a new two-year low set ahead of the weekend near $0.6670. Incidentally, this was slightly above the lower Bollinger Band (~$0.6665). However, the downside momentum was not sustained, and the Aussie popped back above previous support near $0.6695-$0.6700. The daily momentum indicators point lower, but corrective pressure could see a recovery toward $0.6770-$0.6800. On the downside, the target for the head and shoulders pattern (forged mainly in August) is around $0.6600. The (61.8%) retracement objective of the Australian dollar's rally from the March 2020 extreme low ($0.5510) is found near $0.6515.  

Mexican Peso:  For over a month, the US dollar has been chopping in an MXN19.80-MXN20.20 trading range, with a few exceptions, but not on a closing basis. The lower end of the spectrum was rejected at the start of last week. The dollar poked above MXN20.16 ahead of the weekend and met a wall of sellers that knocked it back to almost the middle of the range (~MXN20.20). The MACD is not generating a strong signal. The Slow Stochastic has turned higher. Still, we suspect the dollar can retest the lower end of its range ahead of the FOMC meeting in the coming days. Mexico's paper may still be attractive to fund managers. Consider a three-month cetes yields about 9.5% compared with 3.15% on a US 3-month bill, picking nearly 6.5%. Mexico's 5-year dollar-denominated note pays about 110 bp on top of US Treasuries, and the 10-year pays about 125 bp more than the US.  

Chinese Yuan:  The dollar initially gapped above CNY7.0 ahead of the weekend but came under pressure later in the session and re-entered the previous day's range and settled below CNY6.99.We suspect the dollar can ease toward CNY6.93-CNY6.95. Still, it is the first time the greenback traded above CNY7.0 since July 2020. Recall that the dollar peaked three-years ago near CNY7.1850. It backed off to almost CNY6.8400 and then rallied again to a peak of nearly CNY7.18 in early 2020. The double top was confirmed with a break of the CNY6.84 in September 2020. It had a measuring objective of CNY6.50, seen in January 2021, but the dollar did not bottom until March this year, near CNY6.30. Since then, it initially recovered above CNY6.80 in May, then consolidated at a lower level until around the middle of August. The dollar has risen by about 4.5% over the past month, and Chinese officials would likely welcome some near-term backing-and-filling. The PBOC has tried to manage the exchange rate. Setting the dollar's reference rate considerably lower (for these kinds of things) is seen as moderating the pace of its rise (yuan's decline). This is also consistent with the reduction in required reserves for foreign currency deposits.