Good morning, and happy Saturday.
Investors are shell-shocked after an astonishingly turbulent week. Initial reaction to Tuesday’s overwhelming Democratic victory was positive, with oil prices plunging and equities rallying on hopes the war in the Middle East would be brought to a swift conclusion. On Thursday, the narrative pivoted amid fears that the artificial intelligence buildout would face increasing opposition: technology stocks plunged and measures of expected volatility soared. And the story changed again yesterday, when a blockbuster jobs report underscored the remarkable strength of US labour markets.
On paper, the week ahead looks calmer. US inflation figures on Wednesday and Friday are expected to show price pressures easing slightly in October, helping to refine expectations ahead of next month’s Federal Reserve meeting. A UK gross domestic product report will shed light on whether the economy can withstand repeated rate hikes. There are no other first-tier data releases, central bank decisions, or political events on the calendar.
An acute sell-off in equity markets, however, could see the dollar climb. Although the global technology sector is concentrated in America – which might suggest that a renewed rout should hit the greenback hardest – the currency tends to mechanically outperform when market turmoil hits, as investors cut leverage and seek safe havens. Nor do the alternatives look tempting, with nominal rate differentials remaining deeply negative, and political and energy risks stalking the major economies of Europe and Asia.
A prolonged downturn, though, would work against the dollar through macroeconomic channels. A sustained downgrade in projections for the AI buildout could erode anticipated demand for computing hardware, industrial equipment, and electricity, allowing supply to catch up and helping to lower inflation expectations. Less borrowing by hyperscalers might, in turn, ease upward pressure on bond yields. Weaker wealth effects would feed through to households before long. And tighter financial conditions could weigh on growth more broadly. Should the Federal Reserve no longer need to tighten as aggressively – and should capital flows into the US begin to slow – the dollar could soften.
The upshot is that currency market outcomes may now hinge less on how views on the US technology sector evolve, than on how long the adjustment takes. A sharp, short panic like Thursday’s should lift the dollar, as similar episodes have for decades. But a slow, grinding reappraisal of the AI boom might do the opposite, draining the very flows that have kept the currency aloft. Hedgers hoping for a quiet week should bear in mind that periods of calm in foreign exchange markets often prove, in hindsight, to have marked turning points in underlying narratives.