USD: Main narratives point at stronger dollar

Last week’s action in the FX market conveyed a clear message that it is too early to
turn more structurally bearish on the dollar or bullish on pro-cyclical currencies. This
week, markets may find further confirmation that this is the case, with a few key
threads to follow.
First, US CPI figures on Thursday should show a decline (we estimate from 8.3% to
8.1%) in headline inflation caused primarily by lower gasoline prices, but at the
same time an acceleration in the core rate (we estimate from 6.3% to 6.5%),
mainly driven by housing costs and recreation prices. This should all but endorse
prospects of another 75bp rate hike in November, even if surveys like the University of Michigan should show an easing in long-term inflation expectations.
Second, Fed communication. A 75bp hike for November and a 4.60-4.70% peak rate
are now in the price, but additional hawkish comments – if backed by an inflation
surprise for example – could encourage markets to speculate on larger hikes or a
more prolonged tightening cycle. At this stage, we would see no obvious reason for
the Fed to sound any less hawkish. The focus this week will be on the September
FOMC minutes and a fairly long list of speakers, starting with Charles Evans and Lael
Brainard today.
Third, geopolitical and energy market developments. There have been signs over
the weekend that any optimism over an imminent de-escalation in the Ukraine
conflict may be misplaced. Meanwhile, fears of potential sabotage across European
infrastructure appear to be rising, and with the new EU sanctions on Russia kicking
in, it may be a rocky week for energy markets. OPEC+ recent cuts should keep
showing their effect on crude prices, and offer some (we suspect, temporary)
support to oil-sensitive currencies.
US markets are closed for a national holiday today, so we could see a quieter than
usual start of the week in markets. Moving on, we remain bullish on the dollar, as
the underlying narrative of a hawkish Fed – paired with lingering geopolitical and
energy prices concerns – should keep risk sentiment weak and safe-haven flows
into the greenback strong. A re-test of the 114.76 September high in DXY is our base
case over the next few days.

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