The risk-off environment and coordinated bond/equity underperformance are paving the way for dollar strength. As discussed in yesterday’s FX Daily, overstretched stock valuations looked likely to be tested along with hyperaggressive dovish bets at the start of the year, and good ISM manufacturing figures offset any benign effect on bonds stemming from a larger-than-expected drop in JOLTS job openings.
The FOMC minutes did not have a major market impact, but there are a few important takeaways. First, there is a broad consensus that inflation will decline, but also that the FOMC will keep rates high in case of more persistent price pressures. Markets might have been looking for some validation that the first cut may come as early as March, but the disinflation conditionality does not endorse a move this early. Still, several members saw risks of a rapid worsening in economic and jobs market conditions, which was likely reflected in the more dovish Dot Plot. The biggest surprise was, however, on a quantitative tightening exit, with the minutes showing that members found it appropriate to start discussing the technical factors to slow the unwinding of the balance sheet.
All in all, the minutes were a mixed bag. The conditionality attached to cutting rates is hawkish in the sense that it puts pressure on markets to unwind the March easing bets, but the risks flagged to the economic outlook and discussion about exiting quantitative tightening are unequivocally dovish. The contained impact on the dollar can be explained by the large swings in bond yields and equities yesterday. The dollar is once again more expensive to sell with 10-year Treasuries again close to 4.0%, and the predominance of equity/global risk sentiment as drivers for FX markets means that the dollar dynamics remain strictly tied to markets reassessment of stock market levels.
With equities futures pointing up today, there is a chance for the dollar to give up a portion of recent gains, but we suspect that expectations for a respectable payrolls print tomorrow will prevent large USD corrections. DXY may find a robust floor around 102.00. Today, the focus will be on ADP payrolls, which could move the market but have no predictive power for the official jobs figures.
Francesco Pesole
