US dollar to remain king as Fed continues fight against inflation

Stock markets will remain volatile throughout October and November, with a bearish bias expected in the weeks ahead

Traders at the New York Stock Exchange. Following the large sell-off in risky assets in the third quarter, there was a brief relief rally at the end of September and early October. AP

The US dollar may have kicked off October on a slightly weaker note but the ensuing reversal following a relief rally has been strong.

Since the start of October, the US Dollar Index, a measure of the greenback against a weighted basket of major currencies, was up 1 per cent at the time of writing and approaching 114 levels.

After retesting parity levels, EUR/USD is down more than 1 per cent in October, while the British pound has also dropped 1 per cent lower after teasing 1.15 levels at the start of the month.

US equity markets pared most of their gains on the month and were trading flat at the time of writing. After the large sell-off in risky assets during the third quarter, the brief relief rally through to the end of September and early October was exactly that — a brief bounce after an aggressive sell-off.

What we have seen since is a reversion to the trend as the underlying themes have not changed — a hawkish US Federal Reserve in the face of inflation running above targets.

The most recent US non-farm payrolls report perhaps added more fuel to the fire. The report came in much hotter than expected with 263,000 jobs added in September.

While the reading was slightly lower than the 315,000 new jobs in August, it came in stronger than market expectations.

More critically, the overall unemployment rate dropped to a 50-year low of 3.5 per cent, much stronger than what markets expected at 3.7 per cent.

The report has shown that the US jobs market continues to fire on all cylinders, despite an environment of increasing rates. Judging by the reaction of market, taper expectations or a Fed pivot have been ruled out.

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Watch: US Fed chief warns of 'pain' in reducing inflation

While second-tier supplementary US data, such as purchasing manager indexes, business surveys and housing data point to a slowing US economy, key data metrics such as inflation, jobs and gross domestic product all remain more robust than the Fed would hope.

Inflation is four times stronger than the target, employment remains robust and growth is stubbornly resilient.

At this rate, it is inconceivable that the Fed will revert from its goals stated during its previous meeting (a 75 basis point increase in November, followed by another 50bps increase in December) and the markets are fully pricing this in. Expect the US dollar to remain king.

The fireworks are set to continue throughout October, with volatility expected to peak this month. The economic calendar is filled with data points, which will drive this volatility.

The release of producer prices is expected later today and this is followed by the minutes of the Federal Open Market Committee meeting (due at 10pm Dubai time), which will give us a deeper view on the hawkishness of the Fed.

But perhaps the deal-breaker is Thursday’s all-important US inflation report (due at 4.30pm Dubai time). While energy prices may have fallen last month, lagging housing data will keep the reading elevated.

Markets are currently expecting overall consumer price inflation (CPI) to come in at 8.1 per cent, year on year, (previously 8.3 per cent), while it is expected to be 0.2 per cent, month on month (versus a previous reading of 0.1 per cent).

The core reading, stripped of energy and food prices, is expected to come in at 6.5 per cent year on year (versus a previous reading of 6.3 per cent), while the month-on-month Core CPI reading is expected at 0.5 per cent (versus a previous reading of 0.6 per cent).

Readings in line with these expectations or a hint of these will continue the dollar's upward moves.

It is also the start of earnings season, with several key banks announcing their results this week, followed by Big Tech companies over the next two weeks.

Previous results will not be as scrutinised as forward guidance and I am interested to see how downbeat the future outlook will be.

Overall, expect equities to remain volatile, with a bearish bias in the weeks ahead.

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Looking further ahead, volatility in October is expected to continue through to November.

The next Fed meeting will be held on November 1 and November 2. At the time of writing, markets were pricing another 75bps rate increase with 81 per cent certainty, taking the overall Federal funds rate to a band of 3.75 per cent to 4 per cent.

The US midterm elections are also set to take place on November 8. Currently, the Republican party has a more than 80 per cent chance of seizing a majority in the House of Representatives, while the battle for the Senate is not so straightforward.

Expect volatility to be rife through the final months of 2022 — remain conscious that the underlying themes driving dollar strength still remain. The interest rate differential play will continue to result in the dollar being well bought heading through the fourth quarter.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers