The dollar has dropped nearly 3.0% since last week's highs, as global risk sentiment recovered and ISM manufacturing numbers disappointed. Still, the medium-term story remains US dollar-positive in our view, also due to the grim outlook for Europe. The fiscal U-turn in the UK may not offer sustained support to the pound, while the RBA may keep hiking by 25bp from now on
US Dollar: Correction not very sustainable
The dollar has remained in correction mode at the start of this week, with DXY now trading nearly 3.0% off its September 28 peak. In our view, this has not been accompanied by a radical change in the medium-term narrative that has backed the dollar rally so far: despite somewhat weaker-than-expected ISM manufacturing figures yesterday, the US domestic story remains rather solid, leaving the Fed tightening prospects alive even if markets have recently revised the expected terminal rate to sub 4.50% levels. We see Friday’s payrolls report as a potential trigger for a fresh hawkish re-pricing, and a positive event for the dollar.
Indeed, the fiscal developments in the UK (more in the GBP section below) appear to be having a rather widespread impact on global risk sentiment and have likely favoured a rebound in risk assets and bonds. There is still, however, a long way to go for European assets to regain the market’s favour given the energy crisis and concerning geopolitical developments, so we continue to see any dollar contraction driven by a recovery in European sentiment as likely short-lived.
It is likely that after the ISM manufacturing miss, markets will increase scrutiny on incoming US data to gauge any downward trend in the economic outlook. Today’s data is quite outdated (factory orders and JOLTS job openings for August), which could favour a slightly calmer market environment, but a lot of focus will be on tomorrow’s ISM services index and ADP employment figures. We also have a rather long list of Fed speakers today.
We think the DXY downtrend will soon run out of steam, and some stronger support may already emerge at the 111.00 level. We struggle to see the macroeconomic justification for an extension of the drop below 110.00 at the moment.
Euro: No idiosyncratic support
EUR/USD has largely benefitted from the improvement in global risk sentiment, the dollar correction and some positive spillovers from the fiscal U-turn in the UK, but the euro has still failed to show any substantial idiosyncratic bullish push. This is hardly surprising given the still very challenging outlook for the eurozone and elevated uncertainty about the energy crisis heading into the cold months.
Today’s data calendar is quite light in the eurozone, with only the acceleration in August PPI inflation to keep an eye on. More focus should instead be on European Central Bank speakers as President Christine Lagarde will deliver some remarks this afternoon, following speeches by both Pablo de Cos and Mario Centeno.
In our view, the EUR/USD recovery is looking quite fragile, which means that any slight dollar recovery could trigger a wider correction in the pair. We still see a high risk of a return to 0.9500 over the coming weeks.
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