The dollar is holding steady and Treasury yields are moving sideways as month- and quarter-end flows dominate price action in the foreign exchange markets. After an extraordinarily-tumultuous September, traders are betting the greenback’s safe haven attributes will remain in demand through early October, with other areas of the global economy suffering the repercussions of a rapid ramp in interest rates.
The pound is trading above levels that prevailed before chancellor Kwasi Kwarteng unveiled his government’s tax and spending plans a week ago. The currency rallied this morning as the Bank of England bought long-term gilts and investors bet the government would walk some of its proposed policies back, but gains are eroding as traders assess the deeper economic vulnerabilities exposed during the episode. Expected interest rates remain far higher and the psychological shock to households and businesses has been immense – implying a more violent fourth-quarter economic deceleration than markets anticipated a week ago.
Euro area inflation topped estimates in September, raising monetary tightening pressure on the European Central Bank. Data released by Eurostat showed consumer prices rising 10 percent from a year ago — well above the 9.7 percent increase anticipated by investors — as food and energy costs soared, but the core measure also beat expectations, firming odds on another 75 basis point rate hike in October. The euro is trading roughly 0.5 percent weaker amid broader dollar strength.
Japan spent 2.8 trillion yen — roughly $20 billion — on currency intervention during the month of September, according to numbers published by the Ministry of Finance this morning. Official efforts to support the exchange rate successfully stopped the yen’s descent last week, but most observers expect further weakness as growth and interest rate differentials widen against the currency.
China’s yuan is giving back gains achieved after the People’s Bank of China hardened its opposition to the exchange rate’s decline. The central bank has reportedly instructed state-owned banks to sell dollars in offshore markets, and trade closer to the official fix after each day’s open. In a speech yesterday, Vice Governor Liu Guoqiang warned traders not to “bet on either one-way depreciation or appreciation”, saying, “The longer you bet, the bigger the chance you’ll lose”. Purchasing manager indices for early September, out last night, showed the manufacturing and construction industries enjoying a modest rebound, while the government’s COVID-zero policies pushed the services sector closer to outright decline.
The Federal Reserve’s preferred inflation measure — the core personal consumption expenditures deflator — is expected to climb to an annualized 4.7 percent in August from 4.6 percent in the prior month, even as headline price growth slips to 6 percent. Consumer spending is seen rising 0.3 percent from July, and markets think personal income increased at the same pace.
The University of Michigan’s consumer sentiment index is expected to remain roughly unchanged relative to early September’s preliminary 59.5 reading.
Fed officials talking on topics germane to currency markets today include Vice Chair Lael Brainard, Thomas Barkin, and John Williams. A communications pivot remains unlikely as long as inflation stays above target and employment markets boom, but Brainard — often considered the most dovish member of the Federal Open Market Committee — could be among the first to signal discomfort with the pace of monetary tightening.
Karl Schamotta, Chief Market Strategist