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The US dollar maintains its steady ascent, supported by various factors such as the adjustment of the long-term Federal Reserve funds rate, elevated oil prices, and uncertainties surrounding the trajectories of the European and Chinese economies. In principle, the possibility of a US government shutdown should have a somewhat adverse effect on the dollar, but it may require additional catalysts to reverse this ongoing upward trend.
The US dollar continues to exhibit remarkable strength, having surged approximately 7% since its mid-July low. The occurrence of corrections in this upward trajectory has been infrequent, primarily due to a convergence of several factors. Central to this trend is the robust growth of the US economy and the unwaveringly hawkish stance of the Federal Reserve. Moreover, market sentiment is increasingly shaping around the belief that the next round of Fed easing, whenever it materializes, will not resemble the 300-400 basis point reductions observed in previous decades. This shift has propelled the market's projected low point for the next Fed easing cycle, set approximately three years in the future, to 4.29%. Just last Friday, it stood at 3.99% and was around 3% in the spring. This significant adjustment has played a pivotal role in pushing long-term US interest rates higher.
Simultaneously, elevated crude oil prices, resulting from Saudi supply cuts that have kept the market in a state of deficit (for understand on depth you can read this ING report on this link) , are contributing to a growing disparity between the United States and Europe/Asia. Commodities experts even envision a potential spike in Brent crude oil prices above $100 per barrel. When combined with developments in Europe and China, it becomes evident why the high-yielding US dollar remains highly sought after. In Europe, two new negative factors for the euro have emerged this week - Italy pushing the boundaries of its budget and discussions among some European Central Bank officials regarding substantial increases in Minimum Required Reserves. Meanwhile, in China, the property sector continues to face grim prospects.
I have been emphasizing the need for a softening in US economic data to reverse the dollar's course. However, due to the bleak investment outlook overseas, the threshold for poor US economic data that could induce a reversal has risen. On this note, today's highlights include the Core PCE Price Index, which have demonstrated considerable resilience.
In theory, a US government shutdown should have a slightly negative impact on the dollar, as it would curtail economic activity without directly affecting US creditworthiness. Nevertheless, a substantial catalyst is required to shift the dollar's momentum, and it might remain in demand at least until mid-October when US corporations in California must settle their tax obligations. The Dollar Index (DXY) appears poised to gradually rise to the range of 107.00/107.20. Perhaps the most significant threat to the dollar is the Bank of Japan's potential sale of $20-30 billion near the 150 level in USD/JPY, as Japanese officials closely monitor foreign exchange markets with a sense of urgency.
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