USD: Position adjustment dominates

Tuesday saw a tremendous rally in risk assets, where European equities led the pack by gaining over 4%, high yield credit spreads narrowed 30bp+ and emerging markets bounced back – Romania’s 2051 USD-denominated bond rallied over 10%! In FX, European currencies fought back after recent losses.

Looking back on this period one could probably blame a variety of events such as i) central bank intervention to stabilise markets (Bank of Japan and People’s Bank of China in FX, Bank of England in Gilts) ii) some slightly softer US data and iii) the Reserve Bank of Australia’s smaller-than-expected hike, for contributing to the reversal of the unchecked stagflation trade. Position adjustment and new money being put to work in thin markets at the start of a new quarter may have also played a role.

On the subject of central bank intervention, investors may wait with interest to hear from the G20 on 12 October. We doubt G20 financial authorities will have too much to say about FX markets – but the communique is an event risk. However, we remain sceptical that the Fed is about to pivot on the back of slightly softer US data this week. Focusing on the tight labour supply challenge, the Fed told us in September that unemployment needs to rise from its current 3.7% to 4.4% next year to prevent the Fed funds from going any higher than 4.50-4.75%.

Instead, it looks like yesterday’s outsized reaction was a function of market positioning. We are still multi-month if not multi-quarter dollar bulls and would see this dollar DXY correction running out of steam in the 108.50/110.00 area.

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