Dollar Exchange Rate Outlook: Analyst Commentary and Strategy Post-Fed
- Written by: James Skinner
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"It used to happen, if you remember, in the first quarter of every year. For several years in a row GDP was negative and the labour market was moving on just fine and it turned out to be just a measurement error," - Fed Chairman Jerome Powell.
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Dollar exchange rates were on course for a second consecutive decline in the final session of the week after the Federal Reserve (Fed) said that U.S. economic data will influence the remainder of its interest rate cycle and official figures showed the economy teetering on the edge of recession.
Official figures confirmed this week that the U.S. slipped into a technical recession last quarter with general retailers and motor vehicle dealers running down inventories faster rather than building them further.
Meanwhile, other forms of business investment were also reported lower alongside government spending.
Some economists have suggested the outcome is more of an accounting quirk than it is a sign of distress within the economy due to the role played by sectors that were likely impacted by the April and May reimposition of coronavirus related restrictions on activity in China's port city of Shanghai.
Similar is true of the first quarter in which retail and motor vehicle inventories also played a prominent role driving another unforeseen contraction.
"It used to happen, if you remember, in the first quarter of every year. For several years in a row GDP was negative and the labour market was moving on just fine and it turned out to be just a measurement error. It was called residual seasonality," Fed Chairman Jerome Powell said on Wednesday.
Nonetheless, the data places one more question mark over the outlook for Fed policy barely a day after Chairman Powell said in July's press conference that momentum within the economy and its overall condition would have a greater influence over the pace at which borrowing costs rise going forward.
This small change in the policy bias has implications that raise the importance of data emerging from the U.S. during the months ahead, which the Dollar and many other currencies may now be more sensitive to.
However, all views and forecasts are often nuanced and that hasn't changed since Wednesday's policy update and the subsequent GDP figures.
Below is a selection in no particular setting out what all of this could mean for the Dollar, other currencies and various markets up ahead.
Mazen Issa, senior FX strategist, TD Securities
"Data between now and the September meeting will be the main focus. The USD will show deference to that."
"We think it is appropriate to adopt a neutral stance for now. We think this is more of a USD on pause than an inflection point however. In order for the latter to occur, we'll need a strong EUR."
"With an EU recession expected in H2, an impending energy crisis and a hemorrhaging current account balance, the strategic outlook for EUR remains challenged at best. We are inclined to view EURUSD rallies as limited with 1.0280 and 1.0340 as lines in the sand that are faded."
"We prefer to diversify away from USD exposure and express EUR weakness on crosses. Here, we find the CHF as a viable alternative."
"We would not look for USDJPY topside...we think the pair is finding a comfort zone between 135-140. It remains sensitive to Fed terminal rate pricing but the jury is still out on where that might finally land."
"Where we could see a USD on pause leak into underperformance is against the dollar bloc. Presumably, if the data underwhelms, risk markets will perversely rally as it will likely be perceived as validation that the Fed will have to pivot. That threatens our USDCAD long."
Alfonso Peccatiello, The Macro Compass
"Ditching forward guidance increases volatility in bond markets even further, and a volatile bond market is an enemy for risk assets."
"Let’s assume the next inflation print is worse than expected in absolute terms, momentum and composition. A fully data-dependent Fed will have to consider a 100 bps hike in September: very likely to generate mayhem in markets all over again."
"And a higher volatility in one of the biggest, most liquid markets in the world generally requires higher (not lower) risk premia everywhere else."
Francesco Pesole, FX strategist, ING Group
"The volatile market reaction to yesterday’s poor GDP figures out of the US offered an idea of what we should expect for the coming weeks: an elevated sensitivity of rate expectations and the dollar to incoming data points."
"In our view, this means that dollar-crosses volatility is unlikely to abate in the near term."
"A resilient jobs market is continuing to postpone the prospect of a “real” recession. From an FX perspective, we don’t see the dollar suffering from much more Fed dovish repricing considering the current economic backdrop – only 90bp tightening is priced in by year-end."
"EUR/USD may end the week close to the 1.0200 gravity line."
Andreas Steno Larsen, Stenos Signals
"By ending forward guidance and adopting a meeting-to-meeting approach, the Fed will rely even more on lagging indicators such as the unemployment rate and the monthly CPI report. Once unemployment starts increasing alongside weakening momentum in the inflation reports, it will likely be at least 3-6 months too late to pivot."
"Most leading indicators for inflation point (seriously) down, while early unemployment indicators are ticking up, but the Fed will not admit to it until risk assets have taken another beating."
Adarsh Sinha, FX strategist, BofA Global Research
"We have argued that bad news will be bad for the USD only once the Fed shifts from inflation autopilot to growth data dependence. While Powell's press conference this week referenced data dependence and elicited a dovish market reaction, the Fed's reaction function is still heavily weighted toward inflation."
"In this sense, the Fed is likely to continue hiking at least until the policy rate is slightly restrictive (>3.0%) before attaching greater weight to activity weakness. This may happen after the September policy meeting but until then the USD is likely to remain strong in our view."
Kit Juckes, chief FX strategist, Societe Generale
"The market is long enough of dollars for the correction to continue, short enough of both the yen and the euro to support them. EUR/JPY shorts make sense because EUR/JPY is a lot higher than it was pre-pandemic, Europe’s energy problem is much bigger, and the yen is even more sensitive to US rates."
"You can look at the data any way you like, but the bottom line is that the economy is slowing from an unsustainably frenetic pace, in part because the Fed is tightening aggressively in order to slow the economy down, with the hope that will reverse the trend in inflation (after a suitable lag)."
"The rates market believes that a controlled non-recessionary slowdown is unlikely, and you can see its point! The equity market, whose cup is always at least half full, sees a lower terminal Fed Funds rates and wants to buy this dip."
