Dollar retreats on expectations of dovish Federal Reserve
The dollar lost ground against every major currency last week, as word leaked that ultra-dovish Trump loyalist Kevin Hassett may be picked to replace Jerome Powell as chair of the Federal Reserve.
Highlights:
US dollar loses ground on dovish Fed repricing.
Trump ally Hassett favourite to be named next Fed chair.
Sterling trades higher, despite budget tax hikes.
Yen bounces on hopes of Bank of Japan rate hikes.
RBNZ cuts rates, but signals end to the cycle.
CAD buoyed by strong third quarter GDP data.
Expectations for a cut at the December FOMC meeting have also been growing, and the terminal Fed rate is already just below 3%. Although we think that the market is getting slightly ahead of itself here, the dollar nevertheless retreated toward the middle of the range that has held against its major peers since early summer. The New Zealand dollar was the week’s winner after the RBNZ hinted that its easing cycle has ended.
The US economic calendar remains on the backburner for markets, as most data releases are still quite lagged after the long federal shutdown. However, the September PCE inflation report on Thursday stands out as a potential market mover. Beyond that, confirmation of Trump’s pick for next chair of the Federal Reserve, as well as Powell’s Monday speech are key, particularly with currency markets increasingly driven by the prospects of Fed policy. Eurozone flash inflation on Tuesday will also draw traders’ attention.
USD
The largely lagged data coming out of the US after the shutdown has so far not changed the picture significantly, even if last week’s soft retail sales report was not exactly favourable. Growth remains steady, job creation is subdued but there are no signs of significant labour shedding as yet. While the market is already pricing in significant Fed dovishness at this month’s meeting and into next year, we think there is room for disappointment here.
Whatever loyalist dive Trump ends up choosing to succeed Powell, the normal rotation will add some hawkish voices to the FOMC starting in January, and we expect every potential cut after this month’s meeting to be fiercely fought out inside the committee. Inflation remains stubbornly high at 3% and it has shown no signs of trending back down, quite the opposite in fact, so appetite for an aggressive pace of easing is likely to be minimal.
EUR
The euro seems to be trading mostly as a function of differentials in policy rate expectations across the Atlantic as of late. This Wednesday’s flash inflation report will be important to watch, as individual country reports last week imply a potential for an upward surprise in the key core subindex. If so, this would probably lead markets to price in the possibility that the next ECB move will be an increase instead of a decrease, as has already happened in Sweden with the Riksbank. Such an event may well be the catalyst for the gradual move higher in the common currency that we expect for 2026.
The rest of the week will see a handful of speeches from European Central Bank officials, including from President Lagarde. Retail sales figures on Thursday and the revised third quarter GDP report on Friday will round out the week.
GBP
The Autumn Budget release was taken in stride by market participants, perhaps because much of the content had already been carefully drip-fed over the past couple of weeks. Investors were also comforted by the size of the government’s fiscal headroom (£22bn vs. the previous £9.9bn), which should limit the likelihood of additional tax hikes down the road. We have three big reservations, however: a) the backloaded nature of the tax hikes, notably the freeze to the income tax thresholds, b) the lack of growth in the budget, and c) Labour’s less than truthful account on the size of the hole in the public finances.
For now, the threat to the gilt market seems to have dissipated, and the removal of the budget uncertainty could provide room for a rebound in the pound into year-end. That said, pressure on Chancellor Reeves’ position means that this is unlikely to be plain sailing, and suggestions of government deception and market manipulation won’t go away any time soon. There isn’t much on tap this week, so focus already shifts to the 18th December Bank of England rate decision, with another cut now almost fully priced in by swap markets.