Dollar Falls Sharply as Fed Officials Allow for Smaller Rate Hikes

The dollar index (DXY00) on Friday fell sharply by -1.9%, more than giving back the rally seen on Wednesday and Thursday, and closing the week little changed.  The dollar was undercut Friday as the December 2023 federal funds futures contract eased by -6 bp on a yield basis, indicating mildly less hawkish market expectations for Fed policy.  Nevertheless, the 10-year T-note yield on Friday rose by 2 bp to 4.17%.

The dollar rallied sharply mid-week after the Fed Chair Powell on Wednesday, at the conclusion of the 2-day FOMC meeting, issued generally hawkish comments and said the peak rate for the federal funds rate would likely be higher than the Fed earlier thought. However, that comment was offset to some extent by his comment that the Fed could probably slow its rate hike regime as soon as its next meeting in December.  The current market consensus is for the FOMC to downshift to a +50 bp rate hike at the next meeting in December after four straight +75 bp rate hikes.

Comments by several Fed officials on Friday echoed Mr. Powell’s mixed message.  Boston Fed President Collins said monetary policy is entering a new phase where it makes sense for the FOMC to move interest rates more slowly to balance risks.  She would not rule out another +75 bp rate hike, but she seemed to be leaning towards a +50 bp rate hike at the next meeting since she noted that “a 50 bp move was considered a large move in the past.”

Chicago Fed President Charles Evans on Friday said he expects the Fed to raise rates “slightly higher” than the dot plot projections of September, which are for the funds rate to top out at 4.6% at the end of 2023.  However, he said that stepping back from +75 bp rate hikes makes sense to him.

Minneapolis Fed President Neel Kashkari said Friday’s payroll report showed that the U.S. labor market is “quite healthy.”  He said, “That tells me we have more work to do to try to cool down the economy and bring demand and supply into balance.”  He added, “I had interest rates in September peaking at around 4.9% in the March-April kind of time frame.  Given what I know right now, I would expect to go higher than that.  How much higher than that, I don’t know.”

Richmond Fed President Thomas Barkin on Friday said, “It is entirely conceivable to me we would end up over 5%.”  However, he noted that the Fed might slow the pace of its rate hikes.

Oct nonfarm payrolls rose +261,000, stronger than expectations of +193,000.  Also, Sep nonfarm payrolls were revised upward to +315,000 from the previously reported +263,000.

The U.S. Oct unemployment rate rose +0.2 to 3.7%, higher than expectations of 3.6%, as the Oct labor force participation rate edged down to 62.2% from 62.3% in Sep.

U.S. Oct average hourly earnings rose +0.4% m/m and +4.7% y/y, close to expectations.

EUR/USD (^EURUSD) Friday rallied by +2.1%, boosted mainly by a weak dollar.  The euro was also supported by hawkish ECB comments that pushed the 10-year German bund yield up to a 1-1/2 week high.  Also, an upward revision to the Eurozone Oct S&P Global composite PMI was supportive of the euro.

ECB President Lagarde said, "withdrawing accommodation may not be enough to bring inflation back to our target," and interest rates may need to be lifted to restrictive levels to bring inflation back to the ECB's 2% target.  Also, ECB Vice President Guindos said inflation in the Eurozone would likely remain above the ECB's 2% target for an extended period, raising the risk of a price-wage spiral.

The Eurozone Oct S&P Global composite PMI was revised upward by +0.2 to 47.3 from the previously reported 47.1.

The Eurozone Sep PPI eased to +41.9% y/y from +43.4% y/y in Aug, right on expectations.

German Sep factory orders fell -4.0% m/m, weaker than expectations of -0.5% m/m and the biggest decline in 6 months.

USD/JPY (^USDJPY) fell by -1.0%.  The yen saw some support from comments by Japanese Finance Minister Suzuki that bolstered speculation that Japan could step up its currency intervention efforts when he warned that Japan couldn’t tolerate excessive forex moves, as they can negatively impact households and firms. 

December gold (GCZ2) Friday closed +45.70 (+2.80%), and December silver (SIZ22) closed up +1.354 (+6.97%).  Precious metals prices Friday closed sharply higher, with silver climbing to a 4-week high.  Dollar weakness was bullish for metals.  Silver also soared on speculation China is poised to exit its strict Covid Zero policy, which would boost China’s economic growth and industrial metals demand.  Gold continues to be undercut by fund liquidation as long positions in gold ETF’s dropped to a 2-1/2 year low Thursday.

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