FX Daily: Resuming the Norm – Dollar Gains Momentum as Quarter-End Flows Fade

FX Daily: Back to the status quo

The quarter-end flows effect has faded. Markets are steadily back on a short-bond/long-dollar track, helped by an improvement in US ISM manufacturing and hawkish Fed comments. EUR/USD and GBP/USD look on track to test the 1.0400 and 1.2000 support levels. Meanwhile, the RBA's new governor sent a message of continuity and added pressure on AUD.

 

USD: Reclaiming the crown

We had pointed at quarter-end flows as the likely cause for dollar weakness into the end of last week, and yesterday’s price action set markets back on the short-bonds/long-USD track that has been the norm since mid-July. Two factors have helped this narrative re-consolidate along with the quarter-end effects fading: an improving ISM manufacturing and hawkish Fedspeak.

US September ISM manufacturing beat expectations yesterday, climbing to 49.0 from 47.6. S&P Global Manufacturing PMIs for September were also revised higher to 49.8. As discussed in this note, this is the 11th consecutive ISM manufacturing read in contractionary territory (sub-50). Still, the improvement to the 49.0 level and the close correlation with GDP means we might see a very respectable 4.0% annualised growth print for the third quarter.

That would surely boost the Federal Reserve's soft-landing view for the economy. In the past few days, we have also heard FOMC hawks becoming increasingly vocal about the prospect of more rate hikes in what appeared to be a 'rate protest', with markets only pricing in a 50% implied probability of another rate increase to a peak despite that being part of the dot plot projections. Loretta Mester hit the headlines with a call for another hike this year, following Michelle Bowman’s suggestion that multiple hikes are still needed. Michael Barr struck a more moderate tone but did not rule out another hike.

The USD 2-year swap rate climbed back above 5.0% yesterday, which might now work as a floor with the Fed sending hawkish messages and barring a turn for the worst in US data in the near term. The residual gap between the dot plot projections and market pricing for 2023 and 2024 also indicates good chances that USD short-term rates can build some support.

Expect markets to focus primarily on August JOLTS job openings figures today, the only highlight in the US data calendar. Raphael Bostic – a fairly dovish voice as of late – is the only scheduled Fed speaker.

Volatility in back-end yields should continue to determine the direction of FX moves. Another bearish leg to 4.75%+ in US 10-year bonds can probably keep DXY on track to hit 108.00 in the near future.