The U.S. dollar index (USDX) remained steady above 106 on Monday, stabilizing after experiencing some pressure in recent trading sessions. It received a boost from news that U.S. lawmakers managed to reach a last-minute agreement to avert a government shutdown. A stopgap plan has been approved to keep the government open until mid-November.
The index also maintained its proximity to ten-month highs and recorded a 2.5% overall gain in September, primarily due to the expectation of higher U.S. interest rates persisting for a longer period of time — a policy stance labeled “higher for longer.”
During its September meeting, the Federal Reserve (Fed) chose to keep policy rates unchanged but indicated the likelihood of another rate hike before the end of the year and fewer rate cuts in the coming year compared to previous expectations.
Recent data also revealed that the core PCE price index — the inflation gauge favoured by the Fed — saw a smaller-than-anticipated increase in August. The U.S. economy sustained a relatively strong growth rate of 2.1% in the second quarter.
While the USD remained relatively stable against most major currencies, the dollar to yen rate (USD/JPY) and the Aussie to dollar rate (AUD/USD) both saw notable changes, with the former creeping up to 150 territory and the latter falling to 0.639.
Despite the U.S. government shutdown being averted for now, economists at Commerzbank reported that the risk of one still looms:
“The US government shutdown feared for Oct. 1 is off the table for now, as Congress passed last-minute interim funding. However, this will only last until November 17.
By mid-November, Congress must pass either regular budget legislation or another stopgap funding measure. However, the positions in Congress on the level of government spending and on issues such as Ukraine aid and border security are still far apart. Thus, the 22nd government shutdown since 1976 continues to loom.”
Analysts at TD Securities echoed Commerzbank’s cautious tone and wrote that a short-term pullback in the USD could be expected:
“In a surprise turn of events, Congress managed to avert a US government shutdown by passing a 45-day Continuing Resolution that shifts the funding deadline to November 17.
Given the shutdown was almost universally expected to happen, and have only minimal impacts on any data, we would expect only limited initial reactions on Monday. We would expect 10Y Treasury yields to move 3-5 bps higher due to decreased uncertainty and the USD to weaken by around 0.3%.
The status quo remains biased for rates and the USD higher until data weakens and investors get comfortable taking on duration risk. Beyond the knee-jerk relief, delaying the shutdown risks increasing the hawkish reaction to any upside data surprises.”
The dollar could correct briefly, said analysts at MUFG, adding that the dynamic would ultimately run out of steam:
“This USD weakness could extend further over the short-term but we remain skeptical about this being a sustained turnaround. The move looks technical and month-end flows could be influencing price action.
Yields remain supportive for the Dollar and the ‘higher for longer”’ narrative will only be questioned once the US data turns weaker.”
The dollar has appreciated by around 6% since a recent low in mid-July, with the DXY rising by a similar amount. Economists at UBS shared their updated dollar forecast with FXStreet:
“Until the year-end, we now expect the U.S. dollar to trade sideways against most currencies.
We now forecast EUR/USD, USD/CHF, and GBP/USD to trade at 1.06 (previously 1.12), 0.92 (0.87), and 1.20 (1.29), respectively, by end-December. And in Asia-Pacific, we see USD/JPY and AUD/USD trading at 145 (previously 142) and 0.65 (0.66), respectively, by end-December.
But looking further ahead, relative growth dynamics are likely to run against the U.S. dollar in 1H24. The US economy has yet to bottom, while Europe and China already have.
We expect U.S. dollar strength to peak next year and the greenback to give up some gains. We reflect this in EUR/USD, USD/CHF, and GBP/USD with our September 2024 forecasts at 1.12 (previously 1.16), 0.87 (0.84), and 1.30 (1.36), respectively. This view requires Europe to stay out of recession and China to stabilize.”
Chris Turner, Global Head of Markets at Dutch bank ING, saw the greenback staying bid this week, with continued dollar strength projected in his USD forecast:
“The week ahead sees more manufacturing PMIs around the world – including the US ISM today – and the US data highlight will be Friday's release of the September jobs report. Consensus expects another steady 170-180k headline increase in jobs and unemployment edging back to 3.7%. Average hourly earnings are expected to tick up to 0.3% month-on-month. On the face of it, these numbers will not reverse the Federal Reserve's hawkish stance, nor the strong dollar.
In fact, Friday's release of August income and spending data – including huge back-month revisions – point to the US consumer being in even ruder health than believed. The data warns that strong US consumption can extend into the fourth quarter, and whilst the soft core PCE deflator makes the case that the Fed does not need to hike further, the case for any early rate cuts has also become more distant.
Given that long-dated US yields have been a big driver of the dollar over recent weeks, perhaps a more settled week for the bond market means that the dollar can just consolidate at the highs. We note next week sees US three, ten and thirty-year US Treasury auctions and could be the next big driver for yields – assuming no major surprises from Friday's US jobs report.
DXY should probably stay bid in the 106-107 range this week.”
At the time of writing, DXY was trading around the 106.40 mark, up 0.3% on the day. EUR/USD was trading at $1.054 (down 0.32%), USD/JPY rose 0.24% and edged up closer to the 150 mark, while GBP/USD slid by 0.3% to trade at $1.216. All three currency pairs point to dollar strength potentially continuing in the coming days.
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