USD: No Plaza 2.0

Market participants have continued to push their Federal Reserve rate expectations
higher in the past week, and Fed funds futures are now almost fully pricing in a
5.0% peak rate for the May 2023 meeting. This marks a full 1% increase in peak rate
bets in slightly over a month, largely driven by a firmly hawkish tone in Fed
communication, strong labour data and – only last week – core inflation reaching a
40-year high.
If markets are right, and the Fed is embarking on a path to take rates to 5%, it’s
hard to see the FX market going in a very different direction than the recent, dollar-dominated one, especially in the near term. The implications of an ever-strong
dollar are quite serious for many segments of the global economy, but any attempt
to bring this to the attention of US authorities during the IMF meeting in
Washington last week was surely unsuccessful. On Saturday, President Joe Biden
clearly stated that he is “not concerned about the strength of the dollar”. It’s clear
that a Plaza 2.0 continues to look unlikely, with a voluntary devaluation of the dollar
looking quite a politically hazardous move by an administration scrambling to
contain inflation. If anything, one could speculate that any plan in that direction
would only be publicly discussed after the 8 November Mid-term elections.
We don’t exclude that markets will continue to push their terminal rate
expectations higher (beyond 5.0%) this week, although the trigger will unlikely
come from data. The main highlight this week in the US calendar will be housing
numbers. Skyrocketing mortgage rates are surely taking a toll on house prices
across the developed world but so far, this is being accepted as a “necessary evil”
by central banks. Since shelter represents a third of the US inflation basket, the
housing downturn should actually help drive inflation down faster in 2023. House
prices fell in July for the first time in 10 years and the consensus is centred around
a 7% MoM in housing starts in September.
Our base case for this week is that the dollar will remain supported as the Fed’s
determination to take real rates higher, paired with geopolitical and energy-related
concerns, may keep risk sentiment on the back foot. We suspect that a break above
the 114.70 September highs in DXY is now only a matter of time, and surely
possible by the end of the week.

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