USD: of Fed leads and policy lags

The latest round of G10 central bank policy meetings has clearly put the Fed in the
pole position for the title of most hawkish major central bank. It has further
highlighted that the rest of the G10 central banks are no longer willing to ‘follow the
Fed’ as the FOMC ploughs ahead with rate hikes. Among the reasons for the
emerging divergence between the Fed and most other G10 central banks seems
to be the diverging economic outlook between the US and rest of G10. Indeed, the
US economy is seen as more resilient than its European and Asian counterparts
that are plagued by geopolitical and pandemic headwinds. Importantly, however,
another reason for the apparent hesitance of many G10 central banks to continue
hiking aggressively from here are the lagged effects of the (global) monetary
tightening on the real economy. Given that most of them started tightening
aggressively in early 2022, chances are the first effects of the policy on economic
activity could start showing in the coming months (using the standard textbook
estimate of policy lag of around four quarters). In turn, this means that the Fed will
also have to face up to the consequences of its past tightening policies before too
long. Subsequently, we expect that the Fed’s tightening cycle will peak in early
2023 and see the USD peaking ahead of that, in Q422. Until then, however, the
USD remains the high-yielding, safe-haven King of G10 FX. On the day, focus will
be on speeches by the Fed’s Susan Collins, Loretta Mester and Thomas Barkin.
Fedspeak will also dominate the early part of the week with the main data release
– US CPI inflation for October – not due until Thursday. Evidence that inflation
remains uncomfortably high, coupled with hawkish Fedspeak, should support the
USD’s rate and yield advantage across the board. Elsewhere, tomorrow’s US midterm
elections are expected to lead to Congressional gridlock. The surprise would
be if the Democrats manage to keep the House and Senate, which would raise the
risk of more government spending, higher UST yields and, thus, a stronger USD.

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