USD rebounds after heavy sell-off at end of last week

AUD: RBA signals less confidence in need for further hikes

The US dollar has been rebounding overnight following the heavy sell-off at the end of last week. It has resulted in USD/JPY rising up to an intra-day high of 150.40 while EUR/USD has fallen back below the 1.0700-level. US dollar strength has been most evident against the Australian dollar which has declined by almost 1.0%. The Australian dollar has underperformed overnight even though the RBA decided to raise their policy rate by a further 0.25 point to 4.35%. It was the first hike from the RBA since June. However, the RBA’s updated forward guidance delivered a less hawkish signal over the need for further hikes. The accompanying policy statement dropped the reference that further tightening “may be required”. It was replaced by the statement that “whether” further tightening is required will depend on the data. It clearly signals that the RBA is less confident that further hikes will be needed in the current tightening cycle, and brings it more into line with the thinking of other G10 central banks such as the BoE, ECB, Fed and BoC who have all indicated at recent policy meetings that they are more comfortable that rates have reached sufficiently restrictive levels. The change to the guidance makes us more confident that the RBA’s policy rate has peaked.

The Australian rate market is not fully convinced yet, and is still pricing in around 21bps of hikes by the middle of next year. With the RBA now in data dependent mode, it will require more upside inflation surprises to prompt the RBA to hike further. The stronger than expected Australian CPI report for Q3 was the main reason that the RBA hiked again overnight, and prompted the RBA to note that inflation risks are “proving more persistent than expected a few months ago”. They delivered another hike to be “more assured that inflation would return to target”. The RBA now expects inflation to be around 3.5% by the end of next year and at the top of the 2-3% target range by the end of 2025. It compares to their previous forecasts for 3.25% by the end of 2024 and within the 2-3% range in late 2025. While we doubt that the upcoming data flow will trigger further RBA hikes, the RBA’s concern over persistent inflation risks could deter the RBA from lowering rates prematurely next year. We still see room for the Australian rate market to further pare back rate hike expectations which will act as weight on the Australian dollar going forward. As we highlighted in our FX Weekly (click here), the external backdrop also remains challenging for the Australian dollar with global growth weak and likely to weaken further next year in response to tighter monetary policy. As a result, it will be difficult for the AUD/USD rate to raise back above the 200-moving average at just above the 0.6600-level in the near-term.

FX VOLATILITY HAS FALLEN TO FRESH YEAR TO DATE LOWS

Source: Macrobond & MUFG GMR

EM FX: Dovish repricing of Fed policy outlook triggers sharp EM FX reversal  

It has been a good week for emerging market currencies that have been one of the main beneficiaries from the dovish repricing of the outlook for Fed policy. Over the past week, all emerging market currencies barring the exception of  TRY have strengthened against the USD. The biggest winners have been the KRW (+3.3% vs. USD), BRL (+3.2%), CLP (+2.9%), MXN (+2.7%) and ZAR (+2.6%). Our EM FX index has staged its strongest rebound against the USD since the 1H of July. 

The powerful relief rebound for emerging market currencies was initially triggered by the less hawkish Fed policy update that has since been followed up by the release of the much weaker than expected nonfarm payrolls report for October. At the November FOMC meeting, Fed Chair Powell signalled that the Fed is less confident over the need to hike rates further this year. The recent sharp tightening in financial conditions if sustained will help to slow the US economy and inflation allowing the Fed to look through robust growth in Q3. The case for another Fed hike this year diminished further after the latest nonfarm payrolls report provided more evidence that labour demand continues to slow. The gradual ongoing rise in the unemployment rate has also triggered fresh concerns over recession risk. The developments have encouraged market participants to price back in more aggressive Fed rate cuts into next year. It makes us more confident that US rates and the USD have now peaked for this year. 

The reduction in US yields is initially positive for EM FX and triggered a broad-based improvement in global investor risk sentiment reflecting relief that major central banks including the Fed have likely finished raising rates. It has also resulted in foreign exchange market volatility falling to fresh year to date lows both for developed and emerging market currencies. The ongoing decline in volatility and improvement in global investor risk sentiment has provided a fresh shot in the arm for popular EM FX carry trades such as the MXN. However with the Fed at the end of their rate hike cycle, it should create more leeway for emerging market central banks to keep lowering rates resulting in a further narrowing of yield differentials. USD/BRL dropped back below the 5.0000-level last week even as the BCB lowered the policy rate by a further 0.50 point to 12.25%. In EMEA, the NBP meets in the week ahead and is expected to stick to a slower pace of cuts (0.25 point) after the unfavourable market reaction to the larger cut delivered in September. The main downside risk for EM currencies would be if fears over a sharper US/ global slowdown intensified. Please see our latest EM EMEA weekly for more details (click here).   

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	PPI (YoY)	Sep	-12.5%	-11.5%	!
US	12:30	FOMC Member Kashkari Speaks	--	--	--	!!
US	13:00	Fed Goolsbee Speaks	--	--	--	!
US	13:30	Trade Balance	Sep	-59.90B	-58.30B	!!
CA	13:30	Trade Balance	Sep	1.00B	0.72B	!!
US	15:00	Fed Waller Speaks	--	--	--	!!
CA	16:00	BoC Deputy Gov Kozicki Speaks	--	--	--	!!
US	17:00	FOMC Member Williams Speaks	--	--	--	!!
US	18:30	Fed Logan Speaks	--	--	--	!
GE	19:30	German Buba President Nagel Speaks	--	--	--	!!

Source: Bloomberg