Between a Rock and a Hard Place

Gavin Pearson

Sep 19, 2024

Transcript

Note that the audio is a conversation about the findings in this report. It is experimental AI, created by Google NotebookLM.

Thursday, 19 September, Week 38

Welcome to this macroeconomic report, designed to provide Forex traders with a clear and insightful analysis of the US dollar.

The USD has been on a rollercoaster ride recently, facing downward pressure and hitting multi-month lows against many of its peers. This volatility stems from market anticipation of the Federal Reserve's monetary policy decisions and ongoing concerns about a potential US recession. The recent 50 basis point rate cut, the first since March 2020, has amplified these anxieties. While initially boosting equities, the cut ultimately raised more questions than it answered about the future trajectory of the US economy.

Dominant Theme: Fed's Balancing Act Between Growth and Inflation

The Federal Reserve's efforts to balance supporting economic growth while curbing inflation have become the central narrative shaping trader sentiment. The recent rate cut, exceeding market expectations, signalled a shift in focus towards bolstering a slowing economy. However, the path forward for monetary policy remains uncertain.

Timeline:

September 18th: The Fed surprised markets with a 50bps rate cut, bringing the fed funds rate target range to 4.75%-5%. Despite this move, Fed Chair Powell's remarks, emphasising data dependency and caution, tempered initial optimism, leading to a rebound in the previously weakened USD.
September 13th: Speculation of a larger-than-expected rate cut drove the USD lower. This shift in sentiment was fueled by weaker-than-expected August payroll figures and rising initial jobless claims, adding weight to the argument for a more aggressive rate cut to avert a recession.
August 23rd: Fed Chair Powell’s speech at Jackson Hole signalled the likelihood of a rate cut in September, citing a cooling labour market and slowing inflation.
August 9th: A disappointing July jobs report, with significantly lower-than-expected nonfarm payroll growth and a rise in unemployment, amplified bets for aggressive rate cuts by the Fed, sending US bond yields to multi-month lows and pressuring the USD.

The Geopolitical Landscape

The geopolitical landscape, often turbulent, continues to cast a shadow over the US and the USD. The ongoing conflict in the Middle East, with the recent escalation between Israel and Hezbollah, has added a layer of complexity to the global economic outlook. Concerns about regional stability, potential disruptions to energy markets, and increased geopolitical risk have contributed to safe-haven flows into the USD.

The US-China trade war, a long-standing source of tension, also remains a significant factor. The unpredictable nature of this relationship and its potential impact on global trade and supply chains continue to fuel market uncertainty.

Looking ahead, the geopolitical landscape is expected to remain tense. The upcoming US presidential election could reshape US foreign policy and, by extension, the USD's global standing. The Middle Eastern conflict will continue to be closely watched, with any escalation likely to impact energy markets and, consequently, the US economy. The US-China trade relationship remains a wildcard, with the potential for both escalation and de-escalation impacting market sentiment and the USD's value.

Fiscal Policy

The US is currently grappling with a widening budget deficit, exacerbated by the significant spending programs implemented in recent years. The Biden administration has attempted to balance these spending programs with efforts to ensure fiscal responsibility, primarily through tax reforms targeting corporations and high-income earners.

However, the enactment of the Fiscal Responsibility Act of 2023, projected to reduce the deficit by $3 trillion over the next decade, signals a renewed commitment to fiscal discipline. The long-term sustainability of US fiscal policy, particularly in light of rising healthcare costs and Social Security commitments, remains a key concern for market participants.

The upcoming presidential election, with its potential for significant shifts in fiscal policy depending on the outcome, will be a key focus for investors.

Economic Fundamentals

Consumer spending remains a bright spot, buoyed by a robust labour market and wage growth, but concerns linger about a potential slowdown. The ISM Manufacturing PMI indicates a fifth consecutive month of contraction in factory activity, reflecting headwinds from elevated interest rates and global economic uncertainty.

Despite this, the labour market has shown remarkable resilience, with the unemployment rate remaining near historic lows. Inflation has eased from its peak, but core inflation remains stubbornly above the Fed's 2% target, creating a tricky scenario for policymakers.

Key economic indicators in the upcoming month, such as the September retail sales data, industrial production figures, and the Philadelphia Fed Manufacturing Index, will provide crucial insights into the trajectory of the US economy. The outcome of the presidential election, with its potential impact on economic policies, will also be a crucial factor for investors.

Monetary Policy

Monetary policy continues to dominate the market narrative, with the Fed's recent rate cut and signalling of a more dovish stance generating significant attention. The central bank faces a delicate balancing act between supporting a slowing economy and managing persistent inflationary pressures.

The 50bps rate cut in September, exceeding market expectations, has raised questions about the pace and magnitude of future easing. The upcoming month will be crucial for gauging the Fed's commitment to further rate cuts. The release of key economic indicators will provide insights into the inflationary environment and influence the Fed's policy decisions. Additionally, the FOMC’s economic projections, which currently suggest two more 25bps cuts in 2024, will be closely monitored for any changes.

Macroeconomic Outlook

The US macroeconomic outlook is characterised by uncertainty, with slowing economic growth, persistent inflation, and a shifting monetary policy landscape. The recent Fed rate cut and projected future easing signal a willingness to prioritise economic growth over aggressively curbing inflation.

However, the risk of a US recession remains a concern. The upcoming month will be critical for evaluating the effectiveness of the Fed's actions and the US economy's resilience. Positive data, particularly on consumer spending and the labour market, could alleviate recession fears and support the USD. However, persistent inflationary pressures or escalating geopolitical tensions could hinder market confidence and pressure the dollar.

Key Economic Indicators to Watch

These economic events will be closely watched in the upcoming month, as they could significantly impact the macroeconomic outlook of the US and the USD:

Thursday, 19th September, Week 38: Current Account (United States): Forecast deficit of $-252.0 billion. A wider-than-expected deficit could amplify concerns about the US economy's reliance on foreign capital, potentially weakening the USD. (Lagging Indicator).
Thursday, 19th September, Week 38: Philadelphia Fed Manufacturing Index (United States): Forecast to be 1, indicating a slight expansion in manufacturing activity. A stronger-than-expected reading could signal improving economic conditions, potentially supporting the USD. Conversely, a weaker-than-expected reading could strengthen recession fears and pressure the dollar. (Leading Indicator).
Thursday, 19th September, Week 38: Existing Home Sales (United States): Forecast seasonally adjusted annual rate of 4 million. A stronger-than-expected reading could alleviate concerns about the housing market and potentially support the USD. However, a weaker-than-expected reading could signal continued weakness in the housing sector, adding to recession fears and weighing on the dollar. (Leading Indicator).
Friday, 27th September, Week 39: Core PCE Price Index MoM (United States): Forecast to be 0.20%, reflecting moderate inflationary pressure. A higher-than-expected reading could reinforce the Fed's cautious approach to rate cuts, potentially stabilising or even strengthening the USD. A lower-than-expected reading, however, could fuel expectations for more aggressive easing, potentially weakening the dollar. (Leading Indicator).
Friday, 27th September, Week 39: Personal Income MoM (United States): Forecast to be 0.30%, indicating stable income growth. This data point will provide insight into consumer spending power. A stronger-than-expected reading could support the USD, while a weaker-than-expected reading could signal a potential slowdown in consumer spending, potentially pressuring the dollar. (Leading Indicator).
Friday, 27th September, Week 39: Personal Spending MoM (United States): Forecast to be 0.50%, suggesting healthy consumer spending. A stronger-than-expected reading would support the view of a resilient US economy, potentially strengthening the USD. Conversely, a weaker-than-expected reading could signal a slowdown in consumer spending, potentially weakening the dollar. (Leading Indicator).
Tuesday, 1st October, Week 40: S&P Global Manufacturing PMI Final (United States): Expected to be 47.8, indicating a continued contraction in the manufacturing sector. A weaker-than-expected reading could further heighten recession fears and weigh on the USD. (Leading Indicator)
Tuesday, 1st October, Week 40: ISM Manufacturing PMI (United States): No forecast available. The market will be closely watching this release to confirm if the manufacturing sector remains in contraction territory. A weaker-than-expected reading could add to recession concerns and pressure the USD. (Leading Indicator)
Friday, 4th October, Week 40: Non Farm Payrolls (United States): Forecast to be 130K. A weaker-than-expected reading could solidify concerns about a slowing labour market and increase expectations for more aggressive Fed easing, potentially weakening the USD. A stronger-than-expected reading, however, could suggest resilience in the labour market and support the dollar. (Lagging Indicator)

Conclusion

The US dollar's recent performance reflects a complex interplay of factors, with the Federal Reserve's shift towards a dovish stance, persistent inflation, and a mixed economic outlook shaping trader sentiment. The market is eagerly awaiting the release of key economic indicators in the coming week to gauge the health of the US economy and its potential impact on the dollar.

Here are three key action points for forex traders:

Closely monitor US economic data releases, particularly those related to consumer spending, the labour market, and manufacturing activity. Deviations from forecasts can trigger significant USD movements.
Stay informed about Federal Reserve communications and policy decisions, as they will continue to be a primary driver of USD volatility.
Remain vigilant about geopolitical risks, including the conflict in the Middle East and the US-China trade war, as these events can impact market sentiment and influence the USD's performance.