Why the US Fed's interest rate pause is a win for dollar bulls

Elevated US yields will boost the greenback's strength and exert pressure on other asset classes

Federal Reserve chairman Jerome Powell. The central bank hinted that rate cuts probably wouldn’t be introduced until June. Photo: AP

The US Federal Reserve’s September meeting went largely as expected, with rates unchanged at 5.25 per cent to 5.50 per cent.

However, it was the Fed’s hawkish commentary at its subsequent press conference that kept dollar bulls interested.

While markets have priced in one more rate hike in 2023, the central bank said it was “proceeding carefully” and hinted that rate cuts probably wouldn’t be introduced until June next year – later than it had previously suggested.

The US Dollar Index, a measure of the value of the dollar against a weighted basket of major currencies, caught a bid to close the week more than 0.25 per cent higher, while US equity markets closed much weaker last week.

The US500 index shed 2.94 per cent, while the UT100 tech index was down more than 3.2 per cent.

It seems the momentum of dollar strength has carried into this week. At the time of writing, the US Dollar Index was testing its 2023 highs at 105.90 levels.

US Treasury yields are also catching a bid, which supports the dollar's strength against equities, various foreign exchange and commodity asset classes.

Last week, yields on two-year government bonds hit 5.2 per cent, their highest level since July 2006.

While 10-year yields also tested October 2007 highs at 4.5 per cent last week, it’s important to note that the inversion is still very strong.

Recall that when shorter-term yields remain higher than longer-term yields, similar to what we are experiencing now, this unnatural inversion historically points towards upcoming recessionary conditions.

As long as US yields remain elevated, expect the dollar's strength to remain robust, with all other asset classes remaining under pressure.

Keep an eye out for a triple data release at 4.30pm Dubai time on Wednesday, which includes US gross domestic product, personal consumption expenditure (PCE) prices for the second quarter, and the weekly jobless claims.

US GDP is expected to have edged up to 2.2 per cent during the second quarter, versus a previous reading of 2 per cent.

But it’s the core PCE print – the Fed’s preferred gauge of inflation – that could see short-term volatility.

PCE prices in the second quarter are expected to have slowed to 2.5 per cent from a previous monthly reading of 4.2 per cent.

While we may see a reading above 2.5 per cent due to higher energy prices in this period, the core PCE will be scrutinised more closely.

Core PCE, excluding food and energy, is expected to come in at 3.7 per cent versus a previous print of 4.9 per cent.

Any growth in the core PCE print will keep US dollar prospects stronger, with equities negatively affected.

Finally, the weekly jobless claims number will continue to offer insights into the strength of the labour market.

Recall that a hotter-than-expected jobs market will directly and indirectly keep inflation higher – and the Fed is conscious of this.

Jobless claims have continued to drop, suggesting that fewer people are filing for unemployment benefits in the short term, which has also supported the dollar.

Expectations are for jobless claims to come in at 217,000 on Wednesday.

I am keeping a support level in the US Dollar Index at 104.50, with 107.20 being the next resistance level, which will be tested in the lead-up to the penultimate Fed meeting taking place on October 31 and November 1.

Looking at equities, I expect to see the S&P 500 test 4,300 levels in the next two weeks, followed by 4,240 levels.

Spot gold has been trading in a rather tight range. I expect short-term support to hold at $1,856 levels, with upsides capped at $1,955 levels.

This creates intraday opportunities for day traders. However, remember to deploy stop-loss orders to protect against extended moves amid these uncertain market conditions.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers