Another Fed Jumbo Hike in Focus as Markets Bet on Policy Moderation

US Dollar Fundamentals Forecast: Neutral

  • US dollar weakens as S&P 500 rises, Fed hawkishness bets ease
  • Eyes are on another rise in the jumbo rate of 75 basis points on Wednesday
  • This will be followed by Friday’s non-farm payrolls which are likely to cool

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The US Dollar index DXY fell by more than 1 percent during the last 2 weeks of trading. That was the worst performance in 10 days since mid-July. A couple of reasons can explain the move. The first is an improvement in risk appetite. On Friday, the S&P 500 rose about 2.4%, closing at its highest since late September, fueling demand for the safe-haven currency.

This optimism on Wall Street can be explained by a solid earnings season so far. The second reason for the disruption of the dollar is a moderation in the expectations of the Federal Reserve before the announcement of the monetary policy of November. Looking at the chart below, markets have pulled back projections of a 50 basis point increase in 2023, falling to just a quarter percentage point move.

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The Fed will almost certainly deliver another jumbo rate hike of 75 basis points on Wednesday, bringing rates to 4%. The markets, however, are more interested in what’s next. A 50 basis point increase is priced in for December, followed by 25bps in January. In other words, there are rising expectations of Fed moderation taking place in the financial markets, which is likely to contribute to the rise of the S&P 500 and the decline of the US Dollar.

Are the markets catching themselves? The Fed’s preferred gauge of inflation missed expectations for September, with core PCE running at 5.1% y/y versus 5.2% seen. This is still higher than 4.9% in August. Meanwhile, the Employment Cost Index crossed the wires at 1.2% for the third quarter, down from 1.3% previously. Despite the slowdown in growth, it is still at its highest level since 2003.

So, recent data can go either way if you’re trying to gauge whether inflation is slowing. But, this is certainly much better than if both pieces of data beat expectations. As such, the recent performance of the Greenback appears reasonable. What remains uncertain is how Fed policymakers will approach the pace of tightening in the coming months. Keep in mind that the balance sheet reduction is in full swing.

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Attention then shifts to Friday’s US non-farm payrolls report. The economy looks set to add 190k jobs in October, down from 263k in September. The unemployment rate could rise to 3.6% from 3.5% as average hourly earnings decline. Such a cooldown in the labor market could strengthen the Fed’s moderation language. This could further hurt the US Dollar. Such probability maintains the neutral fundamental perspective.

2023 Fed Rate Hike Expectations

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Chart Created in TradingView

— Written by Daniel Dubrovsky, Senior Strategist for DailyFX.com

To contact Daniel, follow him on Twitter:@ddubrovskyFX



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