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Over the past few weeks, the USD faced some challenges, witnessing a decline from its peak of 107.35 on October 3rd, though this setback remained relatively modest in scale. The dollar index experienced a continuous descent for six consecutive days from October 3rd to 10th, eventually reaching a low of 105.54. This marks the most significant drop for the USD since the first half of July.
Recent market activity suggests that the USD's upward momentum, which was strong throughout the latter part of July and September, is gradually waning. Despite initial gains after a robust Non-Farm Payrolls (NFP) report for September, the USD has been on a corrective trajectory throughout this week. This correction can be attributed to the retreat in US yields.
The 10-year US Treasury (UST) yield, following its recent peak at 4.89% shortly after the NFP report, has since receded to 4.52%. The descent in US yields and the USD was initially instigated earlier this week due to escalating geopolitical tensions in the Middle East concerning the Hamas and Israel conflict, prompting increased activity in government bonds and oil markets. Nevertheless, the overall financial market impact of this conflict has been relatively subdued. Initially, oil prices surged by approximately $6 per barrel.
The Swiss franc has been the standout performer in the FX market last week, capitalizing on the heightened geopolitical risks.
Furthermore, the decline in US rates and the USD can be attributed to a discernible shift in rhetoric from Federal Reserve (Fed) officials since the previous week. There seems to be a coordinated effort by these officials to express greater apprehension regarding the sharp increase in US yields. This surge in yields has led to a notable tightening of US financial conditions, which is akin to one or two 25-basis point rate hikes by the Fed. If market yields persist at elevated levels, it appears less likely that Fed officials will proceed with their plans for a final rate hike later in the year.
These comments from Fed officials have effectively mitigated the upward pressure on US yields arising from strong US economic growth. Additionally, the release of the unfavourable US Consumer Price Index (CPI) report for September has influenced this trend. Current growth projections for US GDP in Q3, as reported by Bloomberg, have averaged 3.5%. However, forecasts anticipate a slowdown to an average of 1.1% in Q4. If economic growth continues to outperform expectations and inflation remains resistant to further deceleration, the possibility of one final Fed rate hike cannot be entirely ruled out.
Given these developments, market participants will be closely monitoring remarks from New York Fed President Williams (scheduled for Tonight) and Fed Chair Powell (scheduled for Thursday) as they both address the Economic Club of New York.
Considering these circumstances, it is anticipated that the USD will consolidate near recent highs in the weeks ahead. The consistent stream of robust US economic data continues to pose upside risks for the USD and US yields, despite the dampening effect of the Fed's rhetoric.
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