USD

The belief among investors that the Federal Reserve would cut rates aggressively in 2024, even in the absence of a growth or employment shock had become near-universal even before the central bank’s decisively-dovish pivot at the December policy meeting. Inflation is fading quickly. Energy and manufactured goods prices are still coming down, and our estimates suggest that the Fed’s preferred measure—the core personal consumption expenditures index—rose less than 2 percent on an annualized basis over the six months ended in November. Unemployment rates remain near historic lows. With the legacy of a three-year surge in deficit spending and credit growth...

Markets risk turning overoptimistic on underlying trends: Fiscal support is turning negative, consumer spending is running on fumes as savings rates run well below, and pre-pandemic norms diffusion indices are pointing to a renewed rise in unemployment rates. Non-farm employment diffusion indices, share of industries reporting growth (unchanged cut by half) As the lagged effects of monetary tightening become increasingly evident in rate-sensitive sectors, we expect recessionary headwinds to grow stronger, culminating in a downturn beginning before June 2024. Warning signs should multiply in the coming months, with economic surprise differentials narrowing against the US. GDP-weighted economic surprise indices

Federal Reserve officials are clearly signalling increasing discomfort with the level of restrictiveness implied in real policy rates. If all else were equal, the dollar would come under sustained selling pressure in the months ahead. But exchange rates have already moved dramatically: Hedge funds and other large speculators are holding a net short position against the dollar for the first time since September, and the greenback has fallen more than 4 percent from its October highs as markets have turned optimistic on returns outside the United States. And all else isn’t equal: Although inflation is headed in the same direction...

For all their drama, presidential elections typically have very little impact on the economy’s near-term direction, and often leave exchange rates effectively unmoved. But in 2024, the stakes for currency markets will be higher. In early campaigning, Donald Trump – the presumptive Republican nominee – has threatened to apply a “universal baseline” ten-percent tariff on all imports – a step that could inflict damage on the dollar’s major counterparts in a repeat of the dynamics seen after the vote in 2016. We think volatility term structures in foreign exchange markets will develop kinks around November’s polling date as the year...