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The US dollar started the week on a strong note, aligning with other traditional safe-haven currencies like the Swiss franc and yen. Despite heightened geopolitical tensions in the Middle East over the weekend, the negative spillover effects on the foreign exchange market have been relatively limited so far. This resurgence has allowed the US dollar index to recover from its dip to around 106.00 on Friday, falling below the previous week's high of 107.35.
The most significant market impact from the renewed conflict between Hamas and Israel, centred around the Gaza Strip, has primarily been observed in the oil market. Brent crude oil prices surged overnight, climbing from Friday's low of USD83.44 per barrel to reach USD88.36 per barrel. This rally follows a substantial sell-off earlier in the month, triggered by Brent reaching a peak of USD97.69 per barrel on September 28th.
Market participants around the globe are now closely monitoring the oil market for signs of continued price adjustments that reflect a higher geopolitical risk premium. This premium accounts for the potential escalation of regional tensions, which could disrupt global oil supply. It's important to note that, at this point, there is no immediate impact on current global oil production, and there are no significant effects on the near-term supply-demand balance or oil inventories.
However, the developments are regarded as bullish for oil prices for two key reasons. Firstly, the likelihood of normalized relations between Saudi Arabia and Israel has diminished, reducing the potential for increased Saudi oil production.
Secondly, even if Israel does not respond immediately to Iran, the repercussions could affect Iran's oil production. This could prompt the United States to tighten sanctions on Iran's oil exports, which have seen a sharp increase to 700,000 barrels per day, making it the second-largest source of incremental supply in 2023.
In summary, these developments are currently seen as supportive of the US dollar in the short term. As for the Cad as well. However, for a more significant impact on the foreign exchange market, the conflict in the Middle East would need to escalate further.
Before the weekend's developments, the US dollar had been experiencing a modest correction lower. The dollar index had closed lower for the fourth consecutive day on the previous Friday, marking the end of an impressive streak of eleven consecutive weeks of gains for the dollar index. Even the release of a much stronger than expected non-farm payrolls report on that Friday failed to breathe fresh upward momentum into the US dollar. This price action indicates that the strong upward trend of the US dollar since mid-July is beginning to exhibit signs of exhaustion, particularly as upward momentum measures have reached stretched levels.
The non-farm payrolls report for September, released before the weekend, provided further evidence of the resilience of the US labour market (you can watch my video where I talk in depth about it on this link;
). It is now less clear that employment growth has slowed as much this year as previously thought. When considering the upward revisions to prior months, employment growth has averaged 266,000 jobs per month over the last three months, which is roughly in line with the year-to-date average of 260,000 jobs per month. However, it's worth noting that these headline figures have been somewhat boosted by substantial monthly increases in government sector jobs over the past three months, totalling 214,000. In contrast, private sector job growth has been averaging around 195,000 jobs per month over the last three months and 184,000 jobs per month over the last six months, compared to an average of 317,000 jobs per month in the second half of the previous year.One aspect of the report that remains reassuring for the Federal Reserve is the slower pace of average hourly earnings growth, which increased by only 0.2% month-on-month in September, marking the second consecutive softer monthly reading. However, despite this, stronger employment growth is likely to keep expectations alive for one final interest rate hike from the Federal Reserve later this year. The next critical release for the Fed, ahead of its November 7th FOMC meeting, will be the latest US Consumer Price Index (CPI) report on Thursday. If the report continues to indicate further evidence of slowing core inflation, it will support the outlook for the Fed to keep interest rates unchanged and could make it more challenging for the US dollar to regain its upward momentum in the upcoming week.
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