And suddenly the Dollar retreats... After a number of positive days that saw the US currency pushing higher against its peers it was time for a move towards the other direction. It was Jerome Powell's comments catching investors off guard yesterday that drove the Dollar lower and now the question becomes whether this is a significant change to its outlook. The European currencies and the commodity dollars are gaining on the back of this unexpected twist of events while Gold also rallied as a response. Equities turned positive in the US on the back of Powell's remarks while Oil pulled back slightly.
Jerome Powell surprised investors yesterday during his New York speech when he mentioned that he sees current interest rates' levels “just below” the neutral rate. This is a significant change in language as up until recently the head of the Fed considered current levels a long way from neutral; this swift in rhetoric hints on the Fed contemplating on slowing down their rate hiking path next year and the Dollar is selling off as a response. It seems that the downtick in the domestic performance figures, the losses in the US stock market and the prospect of a further escalation of the trade dispute with China next year are preventing the Fed from staying on the same tightening path.
On Monday we questioned our long-term call for a weaker Dollar towards the end of the year but it seems that the Fed is sharing our concerns and sends a cautious message. However, does this swift in rhetoric change the outlook for the major currency pairs? Well, the answer is not that clear: the European currencies have their own domestic troubles that prevent them from rallying, with the Euro troubled by Italy's budgetary issues and the Pound vulnerable to Brexit-related losses. At the same time, the commodity dollars are also facing headwinds - being correlated to raw materials' demand - as China's economy is threatening to slow down on the back of Trump's trade war and a further escalation of tariffs is imminent.
So on balance the Dollar should weaken towards the end of the year but this pullback will probably not be as pronounced as one would expect given the domestic issues of the other global economies. At the same time, today's inflation data and the FOMC minutes release will play a role in dictating the short-term price action for the greenback. However, regardless of how the PCE reading comes in today the combination of lower energy prices, stock markets' decline and softer domestic growth don't provide much hope for inflation to tick higher in the long term so investors will likely remain focused on Powell's message and continue selling the Dollar.
Gold clawed back Tuesday's losses following Jerome Powell's remarks and rallied to $1,225 again. A weaker Dollar would be beneficial for the yellow metal and increased tensions between the US and China along elevated risks regarding Brexit's outcome may push prices higher over the medium term. However, for more gains to come in we first need to clear the $1,230 barrier so patience is advised. Oil failed to sustain its rally higher and drops towards $50 again, we should now look for another bounce from this level as prices are looking to consolidate between $50 and $52.
Equities in the US rallied strongly after Powell hinted on a more tempered approach in raising interest rates next year. Investors rejoice but does this change the broader outlook of the US and global equity markets? Yes, but only slightly. Clearly with the Fed thinking about slowing down their hiking schedule and the ECB expressing similar thoughts of delaying tightening in the Eurozone, a lower-than-previously-expected interest rates environment is positive for equities. However, the prospect of a slowing domestic performance in the US and Europe and persisting trade concerns on a global level don't allow for much optimism so we still remain on the defensive regarding the US and European equity markets. Futures are pointing towards a mixed opening bell this morning so investors most likely share our concerns and stay on the sidelines at this time.
MARKET EVENTS TO WATCH
- German Unemployment Change - 12.55pm
- US PCE Core - 5.30pm
- FOMC Meeting Minutes - 11pm
All times are GMT +4.
Written by Konstantinos Anthis, Head of Research