We had pointed to end-of-quarter flows as the likely cause of dollar weakness through the end of last week, and yesterday’s price action sent markets back to the short bond/long USD trajectory that has been the norm since mid-July. Two factors have helped this narrative reconsolidate along with fading end-of-quarter effects: an improving ISM manufacturing and hawkish talk from the Federal Reserve.
The US September Manufacturing ISM beat expectations yesterday, rising to 49.0 from 47.6. The September S&P Global Manufacturing PMIs were also revised up to 49.8. As mentioned in this note, this is the 11th consecutive ISM manufacturing reading in contractionary territory (below 50). Still, the improvement to the 49.0 level and the close correlation with GDP means we could see a very respectable 4.0% annualized growth for the third quarter.
That would surely reinforce the Fed’s soft landing view for the economy. In recent days, we’ve also heard FOMC hawks become increasingly vocal about the prospect of more rate hikes in what appeared to be a “rate protest,” with markets only pricing in a 50% implied probability. of another rate increase up to a maximum. even though that is part of the dot plot projections. Loretta Mester made headlines with a call for another raise this year, following Michelle Bowman’s suggestion that multiple raises are still needed. Michael Barr took a more moderate tone but did not rule out another increase.
The 2-year dollar swap rate rose above 5.0% again yesterday, which could now act as a floor as the Fed sends hawkish messages and prevents US data from turning for the worse in the short term. term. The residual gap between the dot plot projections and market prices for 2023 and 2024 also indicates good chances that short-term dollar rates could generate some support.
Markets are expected to focus primarily on today’s August JOLTS job openings numbers, the only bright spot on the US data calendar. Raphael Bostic – a fairly subdued voice lately – is the only scheduled speaker of the Fed.
Volatility in trailing yields should continue to determine the direction of currency movements. Another bearish leg to 4.75%+ in US 10-year bonds can likely keep DXY on track to hit 108.00 in the near future.