The US dollar fell to new lows on the day across the board (but not yet against the pound).
The market continues to digest Powell’s comments, and the front end of the yield curve remains the place where the strongest buying is taking place. The 2-year Treasury note fell 9 basis points to 3.92%, close to its lowest level of the day, as the longer end moved away from the upper bound.
There’s a lot of talk in the market about 25 versus 50 basis points or where the Fed funds rate will be at the end of the year, but what matters is the final interest rate. Fed officials have been talking about 3% this week or something like “neutrality,” but doing “whatever we can” to support the labor market doesn’t mean stopping at 3% (if necessary).
David Rosenberg also picked up something from Powell and books:
Powell got it right when he said the labor market is now more resilient than it was in 2019. What we know about 2019 is that the Fed was cutting rates all the way down to 1.75%. So let’s just say it’s good to know the end point, which the Treasury market, despite its strength, has not fully reflected.
Now I don’t really think there’s been a signal from Powell about going below 3%, and that decision won’t come anytime soon, but if we get to the point where the inflation debate is over (I think it’s over now), then we need to revisit the idea of where the Fed’s money floor is.
I think that’s what the dollar selloff is all about. A month ago, there was a strong argument that other central banks would cut rates more than the Fed simply because growth was weaker elsewhere. The sentiment on growth is correct, but now we’re discovering that the Fed may not care, and may be determined to keep unemployment here and growth well above 2%.
Now some might argue that this will fuel inflation, but it may not, and the assumption that US interest rates will rise significantly – rather than the Australian dollar – is not a given. With this, the AUD/USD pair is at its highest levels for the day and is threatening to reach its highest levels since July.
AUDUSD Daily
Now, I’m not quite ready to buy into that thinking, because I think it’s too early to be setting the federal funds rate at 1.75%. And there’s the thorny question of the election, fiscal policy, and who will take over from Powell as Fed chair.
So the question is: How crowded is the USD trade and how much money is waiting to get out and pile into cyclical trades like emerging markets? That’s a hard question to answer but that’s likely the way the winds will blow until/unless we start seeing some really weak economic data and global growth.